Four ways to fix the bank problem
It is not clear how bad this crisis is going to be but reform is urgently needed
BANKS are designed to fail. And so they do. Governments want them to be both safe places for the public to keep their money and profit-seeking takers of risk. They are at one and the same time regulated utilities and risk-taking enterprises. The incentives for management incline them towards risk-taking, just as the incentives for states incline them towards saving the utility when risk-taking blows it up. The result is costly instability.
If one thing is clear about the events of the last two weeks, it is that the vaunted reforms introduced after the global financial crisis have not changed any of this that much, or at least not enough.
Yes, the leverage of banking systems has fallen since the crisis. But it remains dangerously high. According to the Federal Reserve, on Mar 8, the difference between the book value of assets and debt liabilities of US commercial banks was US$2.14 trillion. This slice of equity backed assets that were notionally worth US$22.8 trillion. But a recent paper suggests that mark-to-market losses are already around US$2 trillion. A general run would force these losses into the open and wipe out the equity. To prevent this, the authorities may have to protect all deposits.
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