Some concepts of Anglo-American common law applied to Cyprus, ECB, sovereign debt, regulators

Reader comment on: Cyprus Seizures and American Taxes

Submitted by Mark MIchael (United States), Mar 28, 2013 15:11

There are a bunch of important concepts that should be raised by this Cyprus situation. I'll try to enumerate a few in no particular order or importance. A traditional Anglo-American common law principle is that justice is best if those responsible for creating the problem are required to suffer the consequences created by that problem. To pay the bill if it involves financial loss as in the case of banking. The leftist elite have a blindspot about openly, explicitly blaming government actors for their regulatory failures that were part of the problem. For example, when government central banks (CBs) replaced private money center banks as the "bank of last resort", then it is their job to monitor the risk of the banks, their loan portfolios, the amount of their reserves backing up their operations, and if those banks are piling on too many risky loans BLOW THE WHISTLE. Quietly go in and insist they lay off the risky loans, etc.

Instead, the ECB and the EU regulators declared sovereign debt as "riskless." They stupidly made no distinction between the sovereign debt of Germany, Greece, Italy, Spain, Finland, etc. They never changed this explicitly and to this day?! They should be fined, fired, or at least a letter of reprimand put in their file on a Friday night. TANGENT. The SEC put letters of reprimand in 28 of their employees who failed to detect that Bernie Madoff was running a Ponzi Scheme - after 8 separate audits of his books. A couple resigned or were demoted. A harsher penalty clearly was in order IMO.

Another important Anglo-American common law principle is that bankruptcies should follow the Rule of Law. The U.K. and America have detailed bankruptcy laws that govern the resolution of all bankrupt commercial corporations including publicly-held banks. They establish the priority of the creditors and the bankruptcy judge is a dictator who tries as best he can to abide by that pecking order in making decisions about how to allocate the losses. He oversees meetings of the creditors and they hammer out who gets the remaining assets that can be divvied up per that framework of laws.

The idea of the "rule of law" is that private actors - investors - know ahead of time what the rules of the game are and they can invest accordingly. The prices of investments in a "transparent" rule of law environment are based on the likely risk - reward associated with it.

The way the 2008 financial crisis was handled was quite ad hoc and outside the established rule of law, bankruptcy law pecking order, etc. Paulson, Bernanke, Geithner were making it up as they went. Bear Stearns was forced into a shotgun wedding with JPM, creating a serious "moral hazard" in the investor community. If they had gone bankrupt almost surely Lehman Brothers would have behaved differently. They'd have scurried to reduce their risk exposure as fast as they could.

The whole "too big to fail" nonsense was made much worse by Dodd-Frank, since it actually tells big conglomerate banks if they are big enough their bondholders, large depositors know that they will not lose their entire investment - at worst see it tied up for a period of time in bankruptcy and maybe take a small haircut. This gives them an advantage in the marketplace over against small banks. Those banks now are facing lots more red-tape, thanks to the bad behavior of less than 20 large institutions that were at risk in Sept - Oct 2008 and caused the TARP bailout. Those TBTF institutitons have in the end benefited and the small, innocent banks got the shaft.

The Fed's QE1, QE2, and QE3 have forced both short-term and long-term interest rates way down. That is a coercive transfer of wealth from savers and investors to borrowers and those badly-managed financial institutions. The Fed's loose monetary policy has transferred maybe $300B to $400B of wealth from prudent savers to irresponsible economic actors. Prudent, responsible behavior was punished and imprudent and irresponsible behavior was rewarded.

I'd insist that the top echelon of the Fed automatically pay at least a 20% penalty in their annual compensation for this kind of behavior.

They are also the "bank of last resort" for all of the banks within the Federal Reserve system. Their responsibilites include monitoring the quality of the loans, mortgages, reserves, and riskiness of those banks. The fact they failed to do that should also require very public punishment be meted out to them.

Yes, I know the FDIC is tasked with the job of insuring depositors. That means their charter must include monitoring the quality of the loans, riskiness of the banks' operations. The FDIC actually did a very decent job in the crisis once Sheila Baehr took the top job (15 months before the crash). Unfortunately, the bad actors - a handful of very large S&L's (Countrywide, Washington Mutual, Indianpolis XX, etc.) were outside of the FDIC's immediate control.

Okay, I've gone on long enough. In sum, my message is that government actors are given a pass by the elite in and around government, especially the D's. Arnold Kling has his clever expression, "The Two Drunks Model" of banking: the two drunks are the TBTF financial institutions and the government regulators. Sometimes one drunk holds up the other. Sometimes it's the other one. Unfortunately, sometimes it's both of them. Then they both fall in the ditch and the economy gets run over instead.

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