Finance News

Who Should Face the Music When the Banks Fail?

Photo: chrisdlugosz / Flickr

Over the last two years, we’ve all seen who do face the music when banks fail. It’s the average people, the consumers and employees who see their income tank, their jobs disappear, and the prices of everyday products skyrocket. And most of us know that it’s not fair. Average people, after all, are not usually the ones who made poor investments on a large scale or who set up a system that would be initially profitable but unsustainable in the long run.

Yet the people who did make those decisions aren’t being held personally accountable for their actions. While they lost their investments and (sometimes) their bonuses, their overall net worth was not on the line. Many of the high-ranking people who helped cause the recent financial meltdown still have their mansions, private jets, and other trappings of wealth.

Is There Another Option?

James Grant thinks this is wrong. In an editorial for the Washington Post, the editor for Grant’s Interest Rate Observer advocates holding wealthy bankers personally liable if their bank fails. All of their property would be available for auction if people lost money because of their investments and needed reimbursement. This wouldn’t happen very often, though, because Grant thinks that having their own financial well-being on the line would be enough to motivate these people to make sound financial decisions aimed at keeping things running well for years to come.

Grant argues that this structure has worked before. It was the standard structure in America before the 1930s, when people had confidence in the financial system even though most of their investment’s weren’t insured. Brazil has recently instituted a similar policy, and their financial sector is more stable than it has been in years.

Would It Work?

Grant’s is a nice thought. Even though the collected assets of most banks’ controlling stockholders, senior officers, and directors wouldn’t cover the losses sustained if their institutions failed, it would be nice to know that they were suffering at a level commensurate with the misery they’ve inflicted. But would it do more than that?

If Grant’s thesis is correct and laws like this kept banks from failing, they would be worthwhile. However, they would serve their purpose only as long as they didn’t have to be acted upon. They would function mostly to make the top financiers afraid. If the banks still failed, the people still wouldn’t have recourse to enough money to make much of a difference in their suffering.

Would the catharsis of liquidating the assets of wealthy bankers upon the failure of their bank be worthwhile to you, even if the money didn’t come close to reimbursing losses? What choice would you make?

Bonus: For other economics nerds out there, read another plan for forestalling future economic crises. What do you think?

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