Save Europe by Saying No to Bank Borrowing

by Laurence Kotlikoff

Bloomberg
December 14, 2011

The euro crisis threatening the global economy is not about countries going broke. It’s not even about saving the euro. It’s about saving the banks, for the second time in three years.

The banks need saving not because they bought toxic assets such as subprime mortgages or the government debts of Greece, Ireland, Italy, Portugal or Spain, and not because they are too large, overrated or under-regulated. They are in trouble because they bought risky securities with other people’s money, and they have to pay it back. They borrowed to gamble, lost yet another fortune and are facing a massive run.

A run in, say, Italy would force the Italian government to bail out banks. The country can’t print euros, so it would have to go back to its own money to do so -- that is, abandon the common currency.

Why not let the banks fail? Because they control the financial highways that connect borrowers and lenders, savers and investors. Consider the analogy of actual highways: If gas stations had to close down because of gambling losses, the economy would shut down, too.

The right solution is for the government to prohibit gambling by systemically important facilitators of trade, whether they are gas stations or banks.

But how? Simple: Tell banks they can no longer borrow to invest in risky assets while promising creditors full -- and often immediate -- repayment. Nor can they borrow to invest in “safe” assets, such as government bonds. In fact, they can’t borrow in any way, shape or form. Instead, limit them to their sole legitimate purpose: intermediation.

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