Moral Hazard

[ewx]

[Poll #1057683]

(FTAOD I'm not saying that the two situations are identical apart from the scale - I'd hoped 'actually' and 'potentially' would indicate that, if a hint was actually needed.)

Comments

[keirf.livejournal.com]

Yeah, but Farepak was for lower class savers, whereas Northern Rock is for middle class savers...

[aardvark179.livejournal.com]

The two situations are a bit different. In NR's case you want to stop a run on the bank because you believe it can survive, so it won't actually cost you anything, and a bank collapsing could have serious knock on consequences.

[mooism.livejournal.com]

Although I would guarantee the Farepak money, if Farepak had been under greater regulation to start with.

[gerald_duck]

People who give money to some random company to look after get what they deserve; people who deposit money with a recognised bank have more right to expect not to lose it.

But more important is the pragmatic argument: if Northern Rock goes, the entire economy is at risk. Though it may yet be in a pickle anyway.

Plus what aardvark179 said.

[beingjdc.livejournal.com]

Something else. Farepak on the same terms as banks hitherto - £2,000 and 90% of the next £30,000. The distinction between 'some random company' and 'a recognised bank' is increasingly spurious, with Sainsbury's Bank somewhere in the middle. Frankly Farepak's business model was theoretically more solid than Northern Rock's.

If Northern Rock isn't solvent, we shouldn't be bailing it out with taxpayers' money. If it is solvent, someone would have bought it, and the savers would not have suffered, only the shareholders (which would be the right thing).

[gjm11.livejournal.com]

What he said. The government isn't guaranteeing NR deposits out of concern for the welfare of NR customers. If NR goes under it'll effectively cost the government much more than this anyway, and by making the guarantee the government reduces the chance that it will happen. In most scenarios this ends up either neutral or saving the government money.

As for Farepak, I'm all for upping the government's spending on welfare and charity, but it seems to me there are more effective ways they could spend a few million to help people who'd otherwise be screwed than by compensating Farepak's customers. (Better that than nothing, I guess.)

[jiggery-pokery.livejournal.com]

This is a corking post and I have passed links to it onto two other people already. There are differences, as you note and as commenters have noted, but you're the only person I've seen to point out the similarities as well.

I haven't voted. Put me down for "I've thought about it and am not sure."

[gareth-rees.livejournal.com]

By taking deposits Farepak was effectively operating as a bank and I think it should therefore have been regulated as one. If this had happened, it would of course have then fallen under the remit of the deposit guarantee scheme and its customers would have got back 100% of their deposits (since less than £2,000). However, the more likely result would have been that it wouldn't have been able to operate in the regulatory environment and its customers would have had to find other ways to save.

[sidheag.livejournal.com]

Exactly.

[truecatachresis.livejournal.com]

Nobody bought NR because they couldn't borrow the money to do so; that doesn't mean NR isn't solvent. Several banks were interested in buying it, and were convinced it was solvent, but the inter-bank lending just isn't working properly at the moment, so couldn't do so. The BoE only agreed to the emergency loan because they were convinced it was solvent; they would not agree to emergency loans to cover the purchase.

I absolutely agree we shouldn't bail out NR if isn't solvent - that's not what has happened, and not what has been proposed. I think promising to cover all depositors was probably not the right choice, but a continued run on the bank was a bad option.

[truecatachresis.livejournal.com]

IAWTC.

[beingjdc.livejournal.com]

Nobody bought NR because they couldn't borrow the money to do so

In a market, which I would hope the stock market is, by definition, the price of something is the highest amount which someone is willing and able to pay for it. If nobody can afford to buy Northern Rock despite wanting to in principle, then Northern Rock is overvalued, and the share price should have been allowed to continue falling until someone could buy it.

the inter-bank lending just isn't working properly at the moment

'Working' is a rather subjective term. It isn't happening very much, certainly. Risk was being aggressively repriced upwards. The central banks would have done well to let this run its course rather than messing around with it. If I bet on a horse and it loses, it doesn't mean "the bookies isn't working", it means I've lost. Similarly, if no bookie wants to give me odds of ten to one on Chelsea winning, that doesn't mean the betting market isn't working, it means my expectations need to be revised in line with current market conditions.

[pjc50.livejournal.com]

I believe that people are buying Northern Rock shares now, once it lost something like 25% of its value. Of course, that's after the govt announced it wouldn't let it collapse.

I see the BoE's actions as surge protection, or nuclear fission moderation: they could have let NR fail, but that would have aggravated the smaller runs that other banks were seeing and potentially caused a meltdown.

I think there should be a public inquiry into what happened, and probably some sort of punishment for NR's management, but allowing the entire UK financial services industry to become a smoking ruin is not a reasonable cost for punishing the failure of NR. It's not even clear that they did anything wrong yet, or whether it was just some sort of media-triggered panic.

[pjc50.livejournal.com]

?

(I think I agree with Gareth above)

[kaet.livejournal.com]

I agree with Gareth on this one, really. Farepak shouldn't have existed, really, because as far as I can tell they were offering financial services in a way which was incompatible with FSA regulation.

My problem with the moral hazard argument is that there is no real information available to consumers to distinguish financial institutions. Northern Rock a few weeks ago, for example, issued a statement that they were not exposed to US sub-prime mortgages to any degree. At this time they were already looking for a buyer (had hired Morgan Stanley to find them one) because they knew that the increased cost of inter-bank lending was scuppering their business. I think that the various regulatory agencies have failed, essentially, to make this a decision which can made rationally by any savers or borrowers, so I'm not sure that not guarantee invested sums actually avoids moral hazard.

Despite what we see about gaining bounteous wealth from chasing a 0.1% interest rate difference, banking below say, an annual expenditure's worth, is actually a commodity exercise about keeping possessions safe and conveniently accessible, and I think should probably be regulated as such. I think it makes sense to guarantee savings up to, say, three times the median salary (I've no idea what that value is!), and then down at, say, 50% on the rest?

[beingjdc.livejournal.com]

On the contrary, it's extremely clear that they did something wrong, and if they'd done nothing wrong they wouldn't have needed to go cap in hand to the Bank of England (which is when it got in the papers, before any savers had started queuing up).

allowing the entire UK financial services industry to become a smoking ruin is not a reasonable cost for punishing the failure of NR

It's exactly what will happen if the credibility of the British regulatory system is destroyed by this sort of behaviour. Allowing Northern Rock to fail would no more have destroyed the financial services industry than allowing Kwik Save to fail has destroyed the grocery industry. Now there's no incentive not to take risks with your money. The necessary corollary of that is that there's also no incentive for a bank to act responsibly in the marketplace, because they'll always be undercut by irresponsible banks.

I believe that people are buying Northern Rock shares now, once it lost something like 25% of its value.

People were buying them all the way down - if there'd been no buying, there'd have been no selling, and nobody would have known what the price was. For what it's worth, they've lost 75% of their value since Spring, and just over 50% since the start of September. Another 20% or so and someone will make an offer for the lot, which is what would have happened sooner if this stupidity hadn't taken place.

[angoel.livejournal.com]

The question is thus "how do you make people aware of which entities offer the guarantee provided by a bank".

[pjc50.livejournal.com]

What exactly was their mistake(s)?

I'm not sure that "responsible/irresponsible" is a nice clean cut boolean as you're making out.

What was the great non-bailout from which the current credibility of the British regulatory system stems?

My answer is influenced by the facts that (a) the US is experiencing the subprime shakeout and (b) there's a housing bubble; it's a potentially unstable situation and people are jumpy.

[beingjdc.livejournal.com]

Their mistake was to lend out three times as much money as they had in customer deposits, and charge unsustainably low interest rates to the people doing the borrowing. It is clear that if you lend someone money for 25 years, at a rate which is fixed for 2 years, and you yourself borrow that money for only three months, you need to think carefully about what happens if the price of borrowing that money for three months rises above the rate at which you have lent it out for 2/25 years. They did not.

What was the great non-bailout from which the current credibility of the British regulatory system stems?

BCCI, Barings, Equitable Life, Lloyd's of London. Central Bank Independence in general.

Happy to replace 'responsible' and 'irresponsible' with 'low-risk' and 'high-risk'. What we seem to have done now however is even more generous than what we did for Slater Walker, Ansbacher and Keyser Ullman in 1974, when the state was far more widely believed to be the answer to any available problem...

My answer is influenced by the facts that (a) the US is experiencing the subprime shakeout and (b) there's a housing bubble; it's a potentially unstable situation and people are jumpy.

It's not potentially unstable, it's necessarily unstable. That's the thing with bubbles. You can burst it now, and it will hurt quite a bit, or you can keep on blowing until it bursts of its own accord, and it will hurt like all hell.

[lnr]

So did truecatachresis. "I Agree With This Comment".

[lnr]

And incidentally so do I :)

Given that it *wasn't* regulated as a bank I'm not sure what the answer is mind.