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Thursday, July 17, 2008

WSJ: "the book on bank bailouts"

Some recent-historical context for what we're heading into with the US banking system: this is a short WSJ article describing banking crises and subsequent governemnt bailouts in a handful of countries over the past couple decades: Japan, Thailand, South Korea, and Sweden.

The punchline: "This history shows it is almost always a painful process, typically costly to taxpayers and best done quickly."

Japan and Thailand/South Korea episodes I knew something about: Japan with it's "lost decade", as Japan's government/regulatory system got serious only after "allowing troubled banks to limp along and accumulate more bad loans for several years." That followed an asset bubble in Japanese real estate and equities (sound familiar?) .

That wikipedia link is the 1st hit if you google "japan lost decade." 6th hit is this Mpls Fed research paper, which I'd actually downloaded at some point over the past year, but still haven't gotten around to reading. That paper, incidentally, is co-authored by Ed Prescott, who won the Nobel Prize for Economics in 1994.

The banking crisis in Thailand and South Korea followed the Asian financial crisis of 1997-98, which is something I need to learn more about.

I didn't know, however, that Sweden experienced a banking crisis in the early '90s--also due to the collapse of a real estate bubble!

Sweden's experience in the early '90s is often cited as an example of a decisive approach. After a real-estate bubble popped and bankruptcies soared, the government said it would protect all depositors and creditors in its floundering banking system.

It did this by creating government-organized 'bad' banks specifically to manage troubled assets, and set tough conditions in order for banks to get new capital from the government for the surviving banks.

In the end, the government handed over $11 billion to the banks, and the crisis wrung 4% out of Sweden's gross domestic product, according to the World Bank. (For more information, see the World Bank database of banking crises.)

The worry during every bailout is that the act of fixing bank problems will make bank managers complacent in the future, believing they'll be saved when they make mistakes.

One way of limiting this "moral hazard," said Urban Backstrom, former governor of the Swedish central bank, in a later speech, was "to engage in tough negotiations with banks... and enforce the principle that losses were to be covered in the first place with the capital provided by shareholders."

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