Lessons from U.S. Bank and Greek Bailouts

by Joseph Mason

U.S. News & World Report
February 24, 2012

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.

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