The optimal bank crisis policy

In November 2008, the Federal government took a weekend to work out it needed to guarantee all bank deposits (including lending between banks) to stop a potential meltdown. It was a dramatic policy and while right for the times, it didn’t look like a long term solution. Indeed, weeks later, the guarantee had charges and, as of now, it has all been scaled back. Presumably, no one has told the Federal Government that a policy that is of value in a crisis still exists even if you say it is not in place when times are calm.

Anyhow, according to a new paper by Thomas Philppon and Vasiliki Skreta, what the Federal government did on the fly may actually be the optimal policy relative to what occurred elsewhere with bank nationalisations and asset buy-backs. The reason is that guaranteed wholesale lending selects for the right assets to fall into the government hands while the remainder stay in the market. For Australia, it turned out that there were no ‘right’ assets to fall in the government’s hands and what do you know, they didn’t. The US and Europe, by contrast, were not so fortunate.

Now if the Federal government would bother to conduct a full inquiry into the financial system it might just discover that it is doing good. They owe it to us and possibly to themselves to do so.

1 thought on “The optimal bank crisis policy”

  1. Last October, at the Lowy Institute (podcast: http://www.lowyinstitute.org/Publication.asp?pid=1155) both Ross Garnaut and Ian Macfarlane, talking about “the Great Crash of 2008”, strongly regretted that the Australian government had to guarantee wholesale bank borrowings, and expressing their hope that the guarantee  be revoked.  (Listen to Ross at around the 34th minute, and to Ian at around the 37th minute.)  Being a regular reader of CoreEconomics, I was surprised to hear those sentiments from two of Australia’s eminent economists. (Note however that Ross and Ian thought that the Australian government had no choice but to match the guarantees offered by other countries.)

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