Legitimate bank bailout
Further to my post on 5th October, governments in Europe and the USA have come to the same conclusion I did then, that the Paulson plan did not confer sufficient legitimacy when taxpayers’ money is used to support a non-functioning banking system. Only equity stakes, punishing previous shareholders by dilution, combine the enlightened social interests enabled by mixed economies with the helpful disciplines of free-market economies. It was errors in establishing this balance that got us into the problem (errors in monetary policy, bank supervision and the conduct of shareholder responsibilities) and it is as well to get the balance right when we come to sort it out. That applies to immediate actions to prevent a melt-down and longer-term actions to prevent repetition of the errors.
Being in the US at the time, I was annoyed to see the British Treasury falsely praised for its leadership in the co-ordinated initiative to use taxpayer money to recapitalise banks that were unable privately to meet new, higher capital standards. I am more inclined to believe the BBC correspondent Robert Peston’s version of events leading up to the British decision. This has the heads of the main banks telling the Government in no uncertain terms that if it continued with its ad hoc approach of fighting specific outbreaks the forest fire would consume us all. In about 24 hours. Which is what it took to get the announcement we eventually got.
As the markets rightly sensed, avoiding the total collapse of the banking system, which was clearly not being discounted by share prices anyway, does not make a market bottom. What falling share prices are now telling us is that denial about recession risks has ended. From denial to capitulation is still a big gap in market levels, whether it takes a week (1987), two years (1973/4) or a decade (Japan in the 1990s).