Common Threads of Depression

In 1890, the Silver Purchase Act threatened to cause inflation – to the benefit of farmers and miners, at the expense of business interests and banks. As the Great Depression of the 1930s raged, real wages of labourers continued to climb.

The most recent financial crisis was characterised by defaulting sub-prime borrowers, who were lent more money than they could afford. It is no coincidence that in each case, depression was invited or prolonged by politics championing a reallocation of society’s resources.

Regulating Government Intervention Away

Government intervention in the banking sector was motivated by an unwillingness to let banks fail due to ‘systemic importance’. Meanwhile, there was no efficient market for risk because banks expected to be bailed out in their hour of need, even though diversity in this area is extraordinarily beneficial. The solution is smart regulation to eliminate the need for massive government intervention.

NAMA’s Free Lunch for Shareholders

Since first advocating the Nationalisation of Ireland’s banking system in February here, public dialogue has shifted the focus of the debate. Although not lightly considered, Nationalisation is still a better option than the plan currently proposed by the government under the National Asset Management Agency. At least the government would then be pouring money into assets that it already owns, rather than simply bailing out share-holders.

The Problem with Limited Liability

When faced with a collapsing housing market and mounting real burden of debt, it’s entirely rational for households suffering negative equity to simply walk away. This is a major problem in the US, and has exacerbated the banking crisis caused by defaulting borrowers. Many of these consumers might suffer a terrible credit rating as a result, but it still makes sense for them. It seems odd that the market would allow such an insidious example of moral hazard to wreak havoc with the banking system. The guilt of the real culprit is less surprising.

In the US, defaulting home-owners can walk away from their problem after declaring bankruptcy under Chapter 7. There are significant advantages to this option. It allows these people to make a new start, and return to the labour market free from debt. The risk of such defaults is built into banking models, and the costs are distributed amongst other borrowers. However, this system has never been tested under the extremely stressful conditions of a bursting asset price bubble.

Caveat Emptor

It is sometimes the task of those commenting upon government policy to pragmatically limit consideration to those options which are politically possible, and palatable to the vagaries of public opinion. These are the constraints in which public debates takes place.

Government intervention in the market caused the current financial crisis. In the US, artificially low interest rates created the credit which was released to sub-prime borrowers who could not afford it. Politicised lending is recognised now as a major source of the toxic assets plaguing today’s banks. However, the best course of action available today to the Irish government could be the most strenuous government intervention – in the form of nationalisation.