Archives for 2009

There’s been a lot of news (here; here; here) about giving the government expanded powers to take over troubled financial firms and lead them through some form of bankruptcy (these powers already exist with FDIC-insured banks, but not for hedge funds and investment banks). I believe this is a really, really good idea. If something like that were in place now, the banking crisis would be much less severe.

Although I don’t think this is being spelled out clearly by the media, perhaps the biggest problem with banks right now is that they are afraid to lend to each other out of a fear that their lending partner will go bankrupt and they don’t be able to get their money back. To see why they’re worried about this, take a look at how worthless Lehman debt is: a friend of mine who’s a higher-up at a hedge fund says that his fund values their Lehman Europe debt at about 15 cents on the dollar right now. He’s not sure why it’s so little, but it has everything to do with how bankruptcies are administered, since Lehman’s assets and debt were approximately equal in value, meaning that creditors should have been able to get something like 95 cents on the dollar if the assets were sold at market value. Now, suppose that there were a government take-over followed by an immediate mass auction; that might depress the value to the point where creditors got about 70 cents on the dollar, say.

According to my friend, that would be a perfectly acceptable loss. Creditors would take their lumps and get most of their money back and no one would care that much (his words, not mine). Part of the big problem with the current bankruptcy system (and a big part of the reason why Lehman debt is so worthless) is that it takes years and lots of court time for creditors to get their money back.

What’s very interesting here is that a system along these lines would require no government capitalization — it wouldn’t be like the FDIC in that sense.

So that could be the good news that comes out of this big bank mess, some kind of new government-run system of bankruptcy that erased fears of large financial bankruptcies the same way the that the FDIC did with depository banks, and one that didn’t even require any tax-payer money.

Update. In the comments, schrodinger’s cat writes:

Also we don’t need banks and financial institutions that are “too big to fail”.

To paraphrase Bill Clinton, that depends on what the definition of “fail” is. Nearly everyone believes that Citi and BofA *are* too big to fail in the sense that under our currency bankruptcy system, their creditor’s assets (trillions of dollars) would be tied up in court for God knows how long, which would (a) hurt their creditors’ financial standing (and hamper their ability to lend to anyone else) and (b) scare the bejesus out of any institution that was thinking of lending money to any other institution that might go under.

The whole point here is to change what happens when a big institution fails. That way, no one would be too big to fail.

The fire sale next timePost + Comments (50)