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Widening guarantees of new bank liabilities. It may make sense to expand the FDIC’s current program providing guarantees on new debt issuances by banks. This would ensure that everyone could see that the banks will not run out of the cash necessary for their operations, even if there is a temporary panic after the nationalization(s). The policy issues around such guarantees would be substantially different depending on whether the government had decided to protect debtholders of the nationalized bank(s) or force them to absorb a haircut. If the plan is to protect existing debtholders, then the guarantees of new debt would effectively cost very little, since those debtholders would likely have been protected in the future anyway, at least until well past the current economic crisis. Explicit guarantees would be replacing strongly implied ones.

The issue becomes much more complex if the nationalization is accompanied by losses to existing bondholders. On the one hand, the interest rates demanded on new debt issuances by weaker banks would rise sharply, perhaps imperiling their ability to raise capital, which would argue for adding explicit guarantees on new issues for at least a period of time. On the other hand, there would be real consequences to providing a guarantee, since otherwise the government might have chosen to let the full losses fall on the shareholders and debtholders in any future nationalization, as it had just done with this round of seizures.

Broadening the guarantees of deposits. It might also be useful to provide a blanket deposit guarantee or to considerably increase the amounts guaranteed. The Swedes, who have been much praised by advocates of nationalization in the U.S., provided a blanket guarantee of bank liabilities, including both debts and deposits. However, such a blanket guarantee would remove any remaining discipline on banks that results from creditor or depositor caution about the banks’ solvency. It is not clear that there is much discipline of this type remaining for the large banks that are perceived as Too Big to Fail, but the effect is likely still present to some extent at mediumsized and smaller banks.

Announcing a moratorium on new nationalizations of the largest banks for some period of time. This seems like a poor choice since there would be at least a chance that conditions would change, or new information would come to light, that made additional nationalizations desirable. It would be better to deal with the conditions that might create a need for nationalizations, such as through the other actions outlined above, rather than to promise not to do something that might prove to be necessary.

Step 10: Create a sound financial base; institute a good bank/bad bank structure As noted in Step 4, the newly nationalized bank should start with, or swiftly achieve, a capital structure that represents a sound financial base for its desired operations. In addition to capital infusions and the possibility of forcing bondholders to take losses, discussed earlier, it will likely be sensible to create a “good bank/bad bank” structure.5

5 Please see “Good bank/bad bank”, “Nationalization,” and “Guarantees of Toxic Assets” for more on the basic structure.

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