Friday, 3 October 2008

The problem with bail-outs

From the FT, Tue Sep 30th 2008: a very elegant exposition...

    The problem with bail-outs

    If you owe the bank $10, it’s your problem. If you owe the bank $10m, it’s the bank’s problem.

    If you and a million others owe the bank $10 each, it’s still your problem – but now it’s also the bank’s problem.

    If the bank then sells to an investor the $10 you owe, it ought to be the investor’s problem. But if you have a problem repaying the $10 and the bank insured the investor against your problem, then it’s both the investor’s problem and the bank’s problem.

    Your problems and your neighbours’ problems and the investor’s problems mean the bank now owes another bank $10bn. That is both banks’ problem. But if banks can’t or won’t pay the $10bn they owe to other banks, it’s very quickly a $700bn systemic problem.

    And if the government then owes the banking system $700bn, it’s your problem.

    andrew.hill@ft.com

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