Here is a brilliant post by Francis Cianfrocca on the continuing credit crisis. His analysis ranges widely, from Europe to America and back, while still effectively focusing on certain points of shared emphasis. One is that so much of world capitalism no less than world governance is bound up in the principle of protecting private creditors. That principle is at the root of TBTF.
Another point of emphasis, or rather point of recall, concerns the recollection of the plain pulverizing fact that it was Treasury Secretary Paulson’s commitment to liquidationist ethics — that is, a principle of nonintervention which permits even the old and venerable to fail — at the moment of crisis when Lehman Brothers tottered on the brink in Sept. 2008, which triggered the panic that enshrined TBTF for good. Paulson tried to hold a line against the rescue by taxpayers of private capital, tried to call the high finance bluff; but he failed. And in the end, Lehman’s fall and the subsequent tumult of that entire autumn put such a scare in policymakers as to remove such a gambit from toolkit of Western statesmen for the foreseeable future.
Below the fold is a big chunk of Francis’s fine essay. But read the whole thing.
You’ll notice more than a few striking similarities in this to the 2008 crisis touched off by the failure of Lehman Brothers. (To point them all out would be another long post.) Then as now, the primary fear of policymakers was to avoid a “credit event” that would produce a cascade of capital losses among large, interconnected financial institutions. In other words, a meltdown.
At the moment, there are no indications anywhere in capital markets that such an event is imminent. This contrasts sharply with the deeply disordered conditions that prevailed from the summer of 2007 right up to the events of September 2008.
At that time, Henry Paulson drew his line in the sand and told the world that Lehman Brothers would not be supported by extraordinary efforts of US policymakers: Lehman would not be bailed out. Paulson and his team went to tremendous lengths to browbeat other institutions into mergers. But no one was willing or able to acquire Lehman.
Paulson here was trying to do the right thing, but he of all people must have understood that he was threatening the most important assumption in the whole global financial system: PRIVATE CREDITORS NEVER TAKE LOSSES.
It only took three days after Lehman failed for it to become evident that the fallout from that event (which directly affected perhaps one trillion dollars’ worth of assets) would be enough to end the global financial system, and quite likely halt the global economy. That’s the situation that was addressed by TARP, and by a whole raft of asset-purchase programs by the Fed.
Conservatives who think they understand finance like to say that TARP was a huge disaster. Very few of them have any clue that the Fed’s programs were a far larger “disaster” of the same type as TARP. And it’s the same type of thing that the ECB and IMF may now be about to undertake on behalf of Greece.
The fundamental nature of all these rescue programs is to use “social” money (which is ultimately guaranteed by taxpayers) to force up the value of assets that are impaired or valueless. The objective of the rescues is to ensure that PRIVATE CREDITORS NEVER TAKE LOSSES.
In the presence of an open-ended official buyer, holders of Greek debt could either tender (and take an enormous capital gain from current market values); or hold their debt and benefit from the huge interest rates without having to reserve large amounts of regulatory capital against it.
Of course, if the full bailout of Greece happens, the people of Greece will take it in the neck, with onerous fiscal-austerity requirements. They’ll suffer a permanent reduction in living standards, in order to pay back their old debts.
Policymakers will strongly prefer this course of action, and primarily for this reason: because it will allow private creditors in France and Germany to avoid taking losses. No one wants to see a big name French or German bank become the next Lehman Brothers.