back to article So why the hell do we bail banks out?

Much to my joy, I have been asked a question I can actually answer. As opposed to those difficult ones, like does my bum look big in this, do you love me and has your cocaine use ever been more than recreational? That question, coming from commentard John Smith 19, and it is, in essence, well, why do we bail out the banks? …

Re: Wrong question

1) It's not gambling, it's a risk. There's an important difference between the two, and why my earlier Barney Frank quote is so damning. Anybody who doesn't know the difference should never be allowed near the regulatory mechanisms for banking.

2) Because the cost associated with the deposit account probably equal the interest earned on the float, whereas the other is a loan and your failure to pay indicates an increased risk of default. If you are going to actually default, the bank needs to know sooner rather than later. The quicker they can either take you to court to recover their money or write off the loss if that is the case the sooner they can return to profitability.

3) Because the 1950s were a magic time in America. Pretty much everybody else had been bombed to hell and back and we were the only ones with any sort of industrial capacity. That has changed, as it should have.

4) Because the socialists have all decided it's too important to have a banking system that won't fail, so the banks aren't actually a capitalist construct, their a socialist one masquerading as a capitalist one. For the socialists this is a win-win. Their policies always fail so they always get to rail against the capitalists when it is actually their policies which are at fault. You can think of it as a boot stomping on your face - forever.

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Happy

Glass-Steagall Act

Some points about the Glass-Steagall Act by you Tim Worstall.

Are Europen banks as damned unregulated as in the "wild west".

https://www.youtube.com/watch?v=nTWfa-iO9Nc

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100 identical banks are, together, too big to fail

Break up the huge banks. To the extent that the resultant little banks share environments, they'll flock.

So instead of 1 big bank tanking, 100 little banks go off the cliff together.

They all share their regulated environment, for starters. And, given the nature of money, more than that part of their environments are shared.

Isn't this what was true in '07? Seems like they all had to make liar loans, for instance.

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Anonymous Coward

The moment they introduced paper money (and non-paper) as there is no accountability it was destined to go tits up, should have stuck to gold coins...

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Anonymous Coward

should have stuck to gold coins

Assuming for a microsecond you are serious, explain to me the merits of a system where the size of the economy suddenly increases when someone finds gold in a hole in the ground.

An expanding economy needs an expanding money supply; gold only works if the available gold matches the size of the economy. Charlemagne had to use silver currency and start rewarding his followers with land because there wasn't enough gold (partly due to Europe being isolated by Islam). A gold economy is simply unworkable in a modern society, and was already pretty unworkable in the medieval era. If California and South Africa hadn't come along, the end of the gold standard could have come a lot earlier.

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Anonymous Coward

Re: should have stuck to gold coins

That and the global economy meant there were a lot more influencing factors. There's a reason it's called a "hard" economy: it's too rigid, unable to react and flex to changes. That's one main reason countries switched to "fiat" economies.

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Stop

Why not nationalise all the banks?

Surely such a vital element of the economy shouldn't be in private hands, in much the same way as other things that people rely on, like health care and public utilities?

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Anonymous Coward

Re: Why not nationalise all the banks?

People would counter the public sector can't hope to be as efficient in any given industry. And banking requires flexibility because economies can change: sometimes quite suddenly. Anyway, the banking world today is mixed: private companies doing most of the moves with state-run banks providing the backstop.

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Re: Why not nationalise all the banks?

You've noted that most of the public utilities are in fact in private hands? In the UK they most certainly are.....

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Re: Why not nationalise all the banks?

Indeed they are, but they shouldn't be. It always makes me laugh when I hear UK govt ministers claiming that they will lower utility bills, as if they have influence over them whatsoever.

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Re: Why not nationalise all the banks?

This in fact goes to one of my very central questions about government. We keep being told that our public sector can be privatised in order to benefit from industry efficiency / productivity.

Most of us hear this and think - "can't you just get it right as a public company?".

Tim, I ask you a very simple question, why can't a public sector company compete?

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Anonymous Coward

Re: Why not nationalise all the banks?

Public companies simply have different pressures placed upon them. Private companies generally have one chief thing motivating them: turn a profit, or failing that break even. Any company that can't go in the black eventually runs out of capital and has to fold, so there's a natural pressure to perform. Public companies have government backing, so worse comes to worse, the government can allocate funds as needed to keep things running. Plus, being the linchpin of a country, government institutions tend to have an innate (perhaps "macroeconomic") momentum; adding something to the government is a lot easier than taking something out. You can also see this sometimes in apex private companies: ones that have managed to secure a dominant position in their given industry. Once you're at the top, you can take it easy a bit, and those with the ability to do so start to pull strings and try to establish sycophantic bureaucracies (what we'd call "corruption").

Perhaps I'm missing a thing or two, but this should serve as a "nutshell" explanation for the idea of private-sector efficiency.

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Re: Why not nationalise all the banks?

There are four ways in which you can spend money.

You can spend your own money on yourself. When you do that, why then you really watch out what you’re doing, and you try to get the most for your money.

Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I’m not so careful about the present, but I’m very careful about the cost.

Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m sure going to have a good lunch!

Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government. And that’s close to 40% of our national income.

Milton Friedman (1912-2006)

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Re: Why not nationalise all the banks?

It is, in theory, possible for a public sector company to be as efficient (and even, in theory, more) as a private sector one. That isn't, generally, how it works out though.

I've always rather liked the left wing argument about why British Leyland etc failed. Because the management was crap. Well, OK, so I'm not sure I believe that but let's accept it. That means that you're saying that public sector companies end up with crap management. Which could be one reason why they don't do so well.

Another argument often heard is that public sector companies are able to take optimal, not merely profitable, decisions. An example often given was that there's public benefits, public goods, from water and sewage supply. Thus government should run them because only government would provide the larger, optimal, level of investment rather than merely the profitable one.

Which is OK as an argument. Except reality: when the water companies were privatised the investment rate went way, waaaay, up. Because under government control they'd been deliberately underinvesting in order to keep public borrowing down.

But the real argument is that public sector companies are going to be run by politics and politicians. The concerns of politics and politicians don't notably include efficiency. Making sure that my political friends get their share (whether Tories with capitalists or Labour with unions etc) comes rather higher up (err, lower down?) that Maslow's Pyramid for a politician. So, public companies are run for political reasons, not efficiency reasons.

Please do note that this entirely allows such political running of companies to be "better" if that's the way you want to describe it. Fairer, more democratic, whatever. It's just that they're most unlikely to be as efficient given that efficiency isn't the driving concern in how they're run.

There's also an entirely different line of argument. Which is that a monopoly, whether private or public, will be equally inefficient. That it's competition that drives efficiency. And there's no point at all in turning a public monopoly into a private one (and if you do you're going to have to be very careful indeed with regulation, like water, a natural monopoly for an area, or the Grid). Here the argument isn't that the private monopoly will work better, but that if you've got a public company "competing" in a market then the competition is at a disadvantage simply because they don't have that state support. Thus you want to chuck everyone into the private sector so that you do in fact have proper competition.

TL:DR version: public companies could compete but practical experience tells us they don't.

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Anonymous Coward

Re: Why not nationalise all the banks?

"public companies could compete but practical experience tells us they don't"

Girobank competed so well while in the public sector that it had to be shifted from public sector to private, where it could be discreetly shut down without fuss. Fancy that.

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Re: Why not nationalise all the banks?

I'm shocked at the number of (semi)-public French companies running British utilities. Trains, the Severn crossings, etc...

It's like it's ALWAYS better for private industry to run things than the public sector unless the public sector in question is somebody else's.

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Re: Why not nationalise all the banks?

@ Will 28

"why can't a public sector company compete?"

I think they can and they should. For example private pension companies have been having a wonderful time fleecing people with higher charges and the government has responded with NEST. It is a public pension scheme which sticks to low cost index trackers and so should cause the private market to either offer something for the money or to reduce their charges.

The problem with public sector companies is they tend to be monopolies and public or private a monopoly sucks. People complain about privatising the various utilities but the home phone industry exists thanks to privatisation. We now have service and choice! A private monopoly can abuse its position to take money off people for shareholders/directors/etc. A public monopoly forces people to pay it through increased government mandated stealing (tax) while having no requirement to be any good. Neither are good but the public sector is also supposed to be the regulator as well as the provider. Which wastes tax money and becomes unaccountable.

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Anonymous Coward

Re: Why not nationalise all the banks?

" the number of (semi)-public French companies running British utilities. Trains, the Severn crossings, etc... It's like it's ALWAYS better for private industry to run things than the public sector unless the public sector in question is somebody else's."

Close but no cigar.

It's always better for there to be an opportunity for the City to earn megafees.

There are fewer (but not zero) opportunities for the City to earn megafees from pure-public-sector operations in the UK.

Privatisations and arms length and so on offer loads of opportunities for megafees, and who cares about the bigger picture. So, sell the family silver and everything else too, so long as there's a decent cut for the middlemen and advisors.

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Anonymous Coward

Re: Why not nationalise all the banks?

"There's also an entirely different line of argument. Which is that a monopoly, whether private or public, will be equally inefficient. That it's competition that drives efficiency. And there's no point at all in turning a public monopoly into a private one (and if you do you're going to have to be very careful indeed with regulation, like water, a natural monopoly for an area, or the Grid). Here the argument isn't that the private monopoly will work better, but that if you've got a public company "competing" in a market then the competition is at a disadvantage simply because they don't have that state support. Thus you want to chuck everyone into the private sector so that you do in fact have proper competition."

Well, a natural monopoly is the way it is because the market will tolerate EXACTLY ONE entrant. They'll tolerate what would otherwise be eyesore or NIMBY elements as necessary evils if it's coming from ONE necessary source. But once you have MORE than one, then the eyesores become points of contention. Utilities are a prime example of natural monopolies. Utilities carry with them lots of nasty infrastructure as a necessity of their line of work (water pipes, power poles, etc.), and a competitor would need to install their own infrastructure to match, creating the NIMBY issues I mentioned.

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Re: Why not nationalise all the banks?

"It's like it's ALWAYS better for private industry to run things than the public sector unless the public sector in question is somebody else's."

Well, yes, that fits quite neatly into my explanation. The French politicians couldn't give a rat's arse about the British unions, capitalists, politics, voters and so on. Because none of them have any influence over whether a French politician gets elected or not. So, a state run company from outside the polity under discussion might well be able to run a company on efficiency lines.

The end result of this is that the French should run the British trains and the Brits the French ones. Odd, but a logical end stage of the argument.....

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Re: Why not nationalise all the banks?

Given the state of the M48 bridge, their efficiency lines are about on a par with those of local councils who can't be arsed to fix potholes.

Mind you, it is possible to force their hand...

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Re: most of the public utilities are in fact in private hands?

No they're not. They're mostly in that limbo between government run and private. This limbo tends to combine the worst elements of both with the benefits of neither. But sloppy thinking people who are out to help the poor tend to like this arrangement. It makes them feel good.

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Re: Why not nationalise all the banks?

Natural monopolies live in peace with their unicorn neighbors right next door to the Yeti.

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Re: Why not nationalise all the banks?

So how do you live with two competing utilities without having two competing sets of infrastructure (since the utility will also own the infrastructure as a matter of control)? Note that most industries with high upfront but low marginal costs trend naturally toward monopolies simply because this structure always favors the incumbent who's already gotten past the high barrier of entry.

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Wrong Answer

"Banks' gambles are generally less risky than other options"

Not when they take the assets of their retail division to fund the speculation of their gambling division (euphemistically called "investment"). Once upon a time banking was free and banks made an honest living by lending money. Now you get charged for the privilege of putting money into a bank and for the bank to gamble your money on speculative "investments".

"And banking requires flexibility because economies can change"

Flexibility such as the ability to game interest rates and currency exchange rates, offer tax evasion services, and whatever other criminal activities banks have been found guilty of that I have missed.

"Speculation? This is the "ring fencing" that everyone is talking about. Can't use retail deposit money to finance investment banking."

The only way to stop it is a complete separation of retail banking to any other type of banking. The so called ring fencing will only last until the greedy bastards find a way around it.

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The Great American Ponzi Economy doesn't work without larcenous investment bankers flogging vast quantities of phony paper. Real GDP is very small so politicians need the help of colluding banksters who generate paper income in the form of a bubble. The irony is that the more money the banksters steal the healthier the economy appears before the inevitable crash.

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Pint

bank of dave?

anyone else see the documentary of a guy called Dave trying to make his own bank?

Looks like a stitch up.

P.

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Re: bank of dave?

http://www.channel4.com/programmes/bank-of-dave

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FAIL

it's gambling.

they say "managing risk", but it's *gambling*. we gave something like £320 BILLION of tax payers money to bail out failed gamblers in the city of london. they should have not got one penny of our money. now we have zombie dinosaur banks shuffling along, propped up by tax payers money when they should have gone extinct already and allowed fresh new well run institutions to take their place. this is evolution!!

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Re: it's gambling.

I occasionally wondered about just that. What's to stop the CEO of a 'too big to fail' bank from going to the casino and betting the bank's float on 23 red? If it works, the CEO made a masterful investment and gets a bonus. If it loses, the bank gets a government bail-out (and the CEO probably gets a bonus anyhow for their skills in negotiating with the government).

Heads I win. Tails you lose.

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Re: it's gambling.

Not A Single Thing - Just look at some ISDA statistics, the nominal amount of the worlds over-the-counter derivatives (= unregulated junk) just increased during the bailouts meaning that the fu.. er banks were just printing more of the garbage, now that they had the ECB to sell it to!

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FAIL

reserve lending.

the problem we have had with fractional reserve lending is that they have NOT kept to their side of the equation, bbbbbecause *they are gamblers*! the theory is, that 10% of loans go bad, so you need to keep 10% of your loan book *as liquid assets* (i.e. cash), in case of problems. too often it is the case that these piggy bankers have dipped their grubby little trotters into this reserve and gambled with that as well. sooooo when any call comes on this reserve and it's not there, bingo, liquidity problem. these banks should not be bailed out, they should be allowed to go bust and the insolvency process allowed to pick over the bones and sell off anything decent to new investors. the ONE THING banks have to do is manage risk, if they can't even do that then they have failed in their primary function and should fail and be replaced.

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Re: reserve lending.

> the theory is, that 10% of loans go bad, so you need to keep 10% of your loan book *as liquid assets*

I don't think you get the difference between liquidity and profitability.

If 10% of your loans go bad, then you need to charge roughly) 11% more for a loan than you pay for your borrowing. Ie, the 90% of loans that don't go bad, have to finance the 100% of your borrowing.

That is simple profit and loss.

Liquidity is something different - as explained in the article.

Bank borrows a chunk of cash from it's depositors - ranging from *very* short term (ie I get paid at the end of the month and I don't (quite) spent it all at once), through short (say 90 day notice accounts), and medium (various 2, 3,5 year deals). They lend that to some bloke called bollos as a mortgage - for (say) 25 years. Lets assume bollos is a good chap and pays back the mortgage in full - no losses there. But, if the people who lent their money to the bank all want it back quickly - then the bank can'/t repay it there and then. Not because of any bad debts - but simply because they've loaned it out for a longer timescale.

If the depositors wait, then they can all get paid back as bollos pays off his mortgage - and after 25 years they'll all have been paid back in full.

Much the same applies to businesses. There is profit and loss, and there's cashflow.

Put simply, if you sell stuff for more than it costs to buy in/make it plus the costs of paying staff, R&D, rent, etc - then you make a profit. If you sell more, then you make more profit.

But if (say) your customer only pays you 3 months after you have to buy stuff in, and your supplier insists on being paid in 1 month, then you have a funding gap - your cash has to go out before it comes in. So you need some cash reserves - and the more you sell, the worse that becomes.

As an aside, regardless of profitability - most businesses fail on cashflow. Some fail while being healthily profitable, and with good order books.

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Knowledge is power and can be extremely dangerous. Take care, y'all

You said it, Tim …… It's capitalism, stupid! You screw up then you lose everything although it is/is it so stupid in smarter capitalism whenever you screw up someone/anyone else loses everything? It is certainly perverse surely and very corrupting.

And this is a short video which all who have reached this far you might like view to get a deer understanding and firmer handle on the reality of their position in a greater scheme of things ……. The Federal Reserve Explained In 7 Minutes

And all central banks mirror and acts as does the Federal Reserve.

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Anonymous Coward

Re: Knowledge is power and can be extremely dangerous. Take care, y'all

But with a bank, it's not just the bank that loses it. Don't forget the depositors. Unless you're saying they can lose everything through no fault of their own (since it's hard for the average person to notice if a bank is failing until it's already over the event horizon). And before you mention deposit insurance, don't forget small businesses who likely wouldn't be protected as well as those with decent-sized retirement savings over the cap. Plus there's the matter of just who pays to bail out the depositors (the government, meaning taxes or the like) since the bank has no more hide to scalp. Remember, there IS such a thing as the Domino Effect. The American Great Depression started pretty much with one little thing that snowballed, and it took World War II to get America out again. If history repeats, given the scales today, human civilization as we know it might not survive an encore.

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Anonymous Coward

A good read

But I think the why can be explained more succinctly in terms of what would have happened if all the failing banks had simply been allowed to fail. I don't think that would have been pretty. The system failed, yet we were mostly allowed to simply get on with our lives regardless.

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Re: I don't think that would have been pretty.

I don't either. But it would have been prettier than what will happen when if finally all comes falling down. Because it will eventually all come falling down. Bailing them out last time with very little impact on anyone including 95% of the people who caused the mess pretty much guarantees they'll do it all over again. Indeed, we seem to be well on our way with a US stock market bubble that already exceeds the housing bubble.

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So many wrong ideas to make it sound we can do nothing

Wow. Rolling out the Loanable Funds Theory, eh? A real Upton Sinclair effort there.

This has been shown by the various money measures to be be complete ass backwards. Banks make loans, and if they don't have enough reserves they borrow, first from other banks (ah, the Libor), then from the Central Bank. They make money of the spread from the loan to what they borrow.

Next, when a bank is illiquid, "Bagehot's Dictum" is supposed to apply - lend freely against good collateral at penalty interest rates. What was done for the GFC was the only the first part.

Next, apart from a few minor lackeys, no high ranking officials and their ilk have won an orange jumpsuit have paid the price for the GFC, even though scandals of Libor rigging, FX rigging, mortgage fraud, asset mismanagement, etc. have had billions (that is with a B) been paid in fines. Immaculate crimes.

Compare with with the S&L crisis from the late 1980's where over a 1000 folks got prison time (try Charles Keating for a start).

So no, none of this has to be. You can handle illiquid banks, but make sure the incentives kick (like charging high interest) to dissuade bad behaviour.

Then, for crimes, actually send folks to prison. Versus say Eric Holder saying that following up crimes at large banks may have an economic impact. Um, no, again ass backwards.

But articles like this make it sound like we are main street is impotent. It is not, but we have to hold politicians feet to the fire to get this rolling.

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Anonymous Coward

Re: So many wrong ideas to make it sound we can do nothing

"Then, for crimes, actually send folks to prison. Versus say Eric Holder saying that following up crimes at large banks may have an economic impact. Um, no, again ass backwards."

The bank executives learned from the S&L crisis. They always keep themselves (make themselves appear to be) one stage removed from what would be considered the actual decision-making. IOW, they set up a web of plausible deniability and reasonable doubt to turn the law against you. Then one lies, the rest of them swear by it, and the accountants cooked the books long ago.

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Re: So many wrong ideas to make it sound we can do nothing

Well, yes, except in the S&L thing real crimes were committed. You know, stealin' 'n'stuff.

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Fraud, extortion and the right connections

^^ Cause>Threat>Trump card.

That's why we bailed out the banks. All else is smoke, mirrors and crack pipe smoking.

The US and British financial industry literally brought us to the brink of WW3 and the repercussions are still far from assured or safely assumed.

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Re: Fraud, extortion and the right connections

Thumbs down? Not letting facts get in your way I see.

http://www.rollingstone.com/politics/news/secret-and-lies-of-the-bailout-20130104

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Trollface

@every comment

Say that to Worstall's face, in London.

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Devil

But uncle Tim, I want to hear them pigs squeak!

OK, I see why we'd shore up an institution that would create too much collateral damage if it just crumbled.

What I don't get is why the people who oversaw such disasters can get off without so much as a slap in the wrist. Hell, some of them get bonuses!

So long as the banks get our money, can we get their executives to return the favour by doing a little dancing number over at that traditional floor, Ye Olde Gallows? Thank you.

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Anonymous Coward

Re: But uncle Tim, I want to hear them pigs squeak!

Two words: plausible deniability. They can reasonably say this was no fault of their own and they were just triaging, thus they were performing their duty and earned their bonuses, and there's really no way to prove beyond a reasonable doubt they were in on it.

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Re: But uncle Tim, I want to hear them pigs squeak!

In one sense, the people who oversaw it all did get scalped. We loaned the banks central bank cash, against assets, and that kept them liquid. We also then decided that they needed even more money, to keep them solvent, and we gave them that. And took shares in return. So the government diluted the shares of the existing shareholders, in exchange for re-capitalising the banks. And that means that the people who were ultimately supposed to supervise the boards of directors did get scalped. The shareholders.

Of course shareholder democracy seems to have broken down (if it ever worked properly at all). But it's still the shareholders who own the company, and so are taking the risk on their investment. In the case of RBOS, the government now owns 70%, leaving only 30% of the company they used to own to the original shareholders.

A way to claw back bonuses, and to structure bonus incentives better, would also be good. But it's notoriously hard to do.

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Re: But uncle Tim, I want to hear them pigs squeak!

"A way to claw back bonuses, and to structure bonus incentives better, would also be good. But it's notoriously hard to do."

Just thinking out loud but...

Say we have a special share class that is used for share options. The only way to exercise such options is to buy this class of share. When the govt takes new shares for a bailout more shares of this class get issued but the proportion of dividends allocated to such shares doesn't get expanded in proportion so it's only the share option holders who get their shareholdings diluted and devalued. Could this have any traction?

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Re: But uncle Tim, I want to hear them pigs squeak!

I can't recall which bank did this (maybe Credit Suisse?) but a bloody good idea. When bonus time came around everyone's bonuses were paid in those securitised mortgage loans that had fucked up big time.

Did rather concentrate minds.....

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Anonymous Coward

Re: But uncle Tim, I want to hear them pigs squeak!

But it would only work if EVERY bank was forced into it, probably by regulation. Otherwise, a competitor would make an offer to an executive of unrestricted options and steal heads. Look, while the proles hate all the golden parachutes, these parachutes are usually the only things keeping executives in the company and not jumping ship to the competition. High-level executives tend to live in a seller's market meaning they can pick and choose.

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Re: But uncle Tim, I want to hear them pigs squeak!

There is plenty of proof of premeditation and it's right at your fingertips, but they really were/are to big to jail and there is also no shortage of sleazy sycophants apologizing for them.

Start here http://www.rollingstone.com/politics/news/secret-and-lies-of-the-bailout-20130104 and read the entire series by Matt Taibbi.

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