Monday, March 31, 2008

The Nordic Model

I am generally of the mind that banks and other financial insitutions that make bad investments should just be allowed to fail. Failures purge the system of bad companies and allow the system to heal faster. The very last resort should be nationalization as the UK did with Northern Rock. That's why this report disturbs me:

The US Federal Reserve is examining the Nordic bank nationalisations of the 1990s as a possible interim solution to the US financial crisis.

Are financial institutions somehow different? Shouldn't they be allowed to fail? Maybe if depositors lost money they would be more careful in the future about where they park their cash. Maybe if depositors were responsible for their own money, they would demand banks that actually protect their deposits rather than gamble it away on sub prime mortgages.

I haven't said a lot about the Bear Stearns/JPM/Federal Reserve merger but it seems a bad precedent. Bear Stearns was an important investment bank but if it had failed I suspect the banking system would have survived. Would stock markets have reacted badly? Possibly, but is it the job of the Federal Reserve to protect shareholders? The Fed fulfilled its mission as lender of last resort when it provided the 28 day financing on Friday. If that wasn't enough to keep Bear from failing, that should have been the end of their role. Why should taxpayers shoulder the risk of Bear Stearns?

Lastly, does this mean that things are worse than even the most pessimistic believe? If the Fed is studying nationalization of banks and how to do it with minimal moral hazard, do they know of institutions that may need this option? I hope not, but it certainly can't be ruled out.

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