The Bankwatch

Tracking the consumer evolution of financial services

“The world of privatizing the gains and socializing the risks must become a thing of the past” | Mauldin

I look forward to John Mauldin’s weekly emails.  He is pragmatic and fact based in his analysis.  This particular quote today caught my attention as one that summarises the Obama/ Brown (US/ UK) fixation with new debt that addresses an immediate problem yet creates a future one that is much larger. 

The world of privatizing the gains and socializing the risks must become a thing of the past.

And This Thing About Leverage
The problem of too big to fail is ultimately one of leverage. If a small bank fails, no one really notices. If a giant bank fails and puts the system at risk, it costs us a lot. I have a simple proposal to mitigate the problem.

Why not reduce the allowable leverage the larger a bank gets? This would clearly reduce their risk and encourage them to only make prudent bets (otherwise known as loans), as their risk capital would be limited. If they wanted to make more loans, then they could raise more capital or retain more earnings. Would that hurt earnings and shareholders and limit share prices? Yes. And I don’t care. If I’m not getting the dividends, then I don’t want to be made to pick up the tab if there is a crisis. The world of privatizing the gains and socializing the risks must become a thing of the past.

There is a larger message in the title quote.

What Happens If We Do Nothing?
What happens when we have the next credit crisis, when a major sovereign government defaults, as I think will happen? It will be a body blow to many banks, especially in Europe. Once again, we could have banks worried about lending to each other or taking letters of credit, which would be a disaster for world trade and the recovery we are now in.

That we (and Europe and Britain) have taken so long to enact real reform has the potential to really put the world at risk. In the next crisis, we will not have the tools available to stem the tide that we did the last time. Rates are already low. Do you think we could pass another TARP? The Fed’s balance sheet is already bloated.

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Written by Colin Henderson

April 10, 2010 at 00:28

Posted in Uncategorized

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