Joseph Mason is the Moyse/LBA Chair of Banking at the Ourso School of Business at Louisiana State University and a senior fellow at the Wharton School of the University of Pennsylvania.
Former U.S. Treasury undersecretary for international affairs John Taylor's recent commentary "A Better Grecian Bailout" in February 22's Wall Street Journal was spot on, but five years too late. Replace the term "Grecian" with "Bank" and you have the main object lessons for the U.S. bank bailout that were, of course, not followed.
Taylor notes how investors,
denied the possibility of a write-down, claiming that the problem was illiquidity not insolvency. Many of us with experience from emerging market crises of a decade or more ago recommended admitting the insolvency problem from the start, restructuring the debt, and moving on with economic reform.
As you may recall, that dynamic was (and is) the same for financial institutions failures. The initial claim was that the bank problems were only illiquidity, ignoring the massive write-downs necessary to recognize the realities of real estate markets. Such write-downs are still dragging on and the banking sector is still unable to support economic growth. It would have been better to have admitted the large banks were insolvent from the start, restructured them, and moved on immediately with reform.
Taylor goes on to discuss the bogeyman of contagion, noting, "In my view, fears of contagion were exaggerated… by people who stand to benefit from bailouts or lose from write-downs. ... But contagion is unlikely if policy is predictable." Certainly, key policymakers and regulators were unaware of the existence of the "shadow banking sector" in 2006-07. But that is no excuse for bad bank policy that substituted knee-jerk reactions for judicious assembly of resources to understand and systematically address difficulties in key banking markets that had existed for more than two decades.
Last, Taylor notes how it is not only fiscal policy that hampers Greece's recovery, but institutional frictions like legal, regulatory, and cultural constraints, that impede long-term economic growth. In other words, those knee-jerk policies—enacted in the United States in the name of unspecified "illiquidity" and "contagion" as well as "market inefficiency" rather than with thoughtful consideration—will hamper U.S. economic growth for years to come.
Taylor notes that the reforms now needed in Greece are "less about austerity and more about what the International Monetary Fund (IMF) appropriately calls 'growth enhancing structural reforms'—more reliance on private markets, incentives and the rule of law." Current policies in the United States should be pointed in a similar direction.
While all of this makes sense, the United States continues to move in the opposite direction. The IMF for decades has addressed banking crises worldwide and for the past decade or more focused on far more than fiscal austerity. But opponents of implementing such suggestions in the United States continue to allege that the United States is somehow "different" and should not be bound by lessons about distinguishing illiquidity and insolvency, motivating systemic frictions in the name of contagion, and the dangers of structural impediments to economic growth. I only hope the resilience of capitalism and democracy can save us from Grecian decline.