17 July 2008

A Different Kind of Bank Robber

IndyMac Bank, with $32 billion in assets ... became the third-largest bank to
fail in American history and the fifth bank failure so far this year.

The catch-22 with banking is this. If a bank collapses, it can take other banks with it - potentially triggering a wave of bank failures that hurts the whole economy. If a community does not intervene and bail out the bank, it risks a widespread economic downturn. If a community does intervene and bail out the bank, it might encourage risk-taking among banks who are aware that they'll be bailed out.

Perhaps I am too simplistic, but couldn't communities go far in mitigating this moral hazard with the following simple strategy? Bail out banks in order to mitigate the spread of bank failures but also make it clear to executives of the bank that they'll be liable for serious penalties (even jail time?) if they've taken risks that put the bank in a position of needing to be rescued.

Bailing out banks costs taxpayers billions, whereas actual bank robbery usually costs only thousands. It is, oddly, a form of bank robbery when executives accept outrageous risks that won't, in the end, be a risk to them. We already have laws for bank robbers. Perhaps it is simply time to re-define who those people are.

10 comments:

Jennifer H said...

Here in Arizona we have a Stupid Motorist law that fines drivers who have to be rescued after they go around a barricade to cross standing/flowing water. The fine is a minimum of $2000, plus additional fines for each firefighter or rescue person at the scene, and for each piece of equipment used.

In the case of banking, perhaps the bankers are taking risks that won't harm them, but I think your idea makes a lot of sense.

Also, shouldn't they have to wear ski masks (or panty hose!) for a specific amount of time, as part of their penalty? As bank robbers and all...

Ron Davison said...

Jennifer,

That's an hilarious image - executives discussing risk acceptance plans breaking out the ski masks as a way to signal that they're pushing the envelope for risk return.

Jennifer H said...

It could catch on. ;-)

But if they wear the look with the sort of swagger that our current admin shows, we might be in more trouble than before.

Off point: Do you think Halliburton sells ski masks in their company store?

Big Al said...

What we're talking about here is accountability. As long as the FDIC guarantees deposits by commercial banks up to $100k, we'll have bank execs who take risks. Let me explain further . . .

Banks are classified in 5 groups according to their risk-based capital ratio. When a bank becomes undercapitalized the FDIC issues a warning to the bank. When the number drops below 6% the FDIC can change management and force the bank to take other corrective action. When the bank becomes critically undercapitalized the FDIC declares the bank insolvent and can take over management of the bank.

So where's the accountability to bank execs if the FDIC declares insolvency and takes over management? "Gee Mr. Exec with your incredibly hefty salary, you made some bad investment decisions and we're going to punish you by taking over your business." This basically allows bank execs to legally gamble with depositors funds w/o any penalty. Everybody but the bank execs are paying for bank execs failures. In fact, I'd say it promotes risk.

cce said...

I have little to add to this one save for the fact that I favor the money under the mattress scenario at this point. It's how I used to handle all waitressing tips back in college and it feels pretty damn secure considering the alternatives.

Big Al said...

cce,

I have a friend who places money in fireproof boxes and hides it in various places around their house. They're self-employed and have been hoarding for many, many years. They figure it's much safer than having the cash in our banking system. When I asked, "of course you're reporting all your earnings, right?" They just smiled . . .

Dave said...

An unidentified friend of mine, involvolved somewhere in the regulation end of the banking business, says "you ain't seen nothing yet."

Lifehiker said...

The stockholders of a failed bank lose 100% of their investment. Youy would think that the board of directors of a bank would be the "protectors" of those people, but that's not how it works. The boards are too closely tied to management.

You'd also think that the regulators would be the backstop for non-functional boards. Not so, it appears. When an entire industry gets involved in risky investments like sub-prime loans, who are the bad guys? All of them?

IndyMac's failure resulted from lack of action at the very top of our government. Only the president, the congress, or the Federal Reserve had enough clout to stop the sub-prime train before it ran off the tracks. But the real estate, banking, and investment industries had too much political influence, so nothing was done.

Ron, at bottom this is just another great example for your point that corporations run America. In this case, they ran America into the ground.

HRH said...

Amen.

I am loving the above comments as well. The R World think tank is fast at work. I would like to join...I can bring snacks.

Ron Davison said...

ALLEN!
Thank you for the education. Seriously. And yes, I do think that moral hazard plays a part in this.

cce,
money under the mattress works as long as you don't smoke in bed, I suppose.

ALLEN!
the fireproof box scenario sounds like a great idea to me. Do you have an address?

LH,
the top rarely topples and when it does, it seems to fall onto us common folk.

Holly,
We'll do that - have a working lunch as we huddle around the issues of the day. Great idea. Thakns.