The world is wasting a good crisis
Rahm Emanuel, President Barack Obama’s former chief of staff, popularized the motto that one shouldn’t waste a good crisis. But there is a severe risk that this is precisely what the world has been doing by being excessively soft in bailing out banks and countries since Lehman Brothers went bust in 2008.
Bailouts, such as that being negotiated for Ireland, may be needed to prevent a descent into chaos. But the conditions must be tough. Otherwise, the world won’t learn the lessons from the crisis and justice won’t be seen to be done.
Ireland’s original bank bailout in the wake of the Lehman bankruptcy is one of the most egregious cases of excessive softness. Dublin gave a blanket guarantee to its banks’ liabilities, including wholesale funding. A more targeted guarantee focusing on retail deposits would have been far better. Not only would the creditors have been punished; the state itself wouldn’t now need its own bailout.
But it wasn’t just the Irish who were soft. The Americans gave their top banks excessively cheap capital in October 2008. And many euro zone governments helped sweep the problems with their banks under the carpet post-Lehman. Even this summer’s stress tests were a half-hearted affair. One consequence of this softness is that banks in supposedly strong countries like Germany are still too weak to withstand the bankruptcy of a small country like Greece or Ireland. Another is that the world is still stuck with banks that are too big to fail—a problem that the new Basel III banking reforms will only partially remedy.
The excessive softness has also distorted monetary policy. It’s not just that interest rates have been kept at ultra-low levels; liquidity has been sprayed at banks on incredibly attractive terms. Meanwhile, the U.S. Federal Reserve and the Bank of England have taken the extraordinary measure of printing money to boost economic activity.
Extreme circumstances call for extreme measures. But the hot phase of the crisis in most countries has passed—and so should the extreme measures. What is left is a long grind back to prosperity. That’s unfortunate, but there’s no way that the excesses of the bubble years can just be conjured away. Remember that it wasn’t just banks that lived high on the hog. During the boom, many ordinary people—whether in Ireland, Greece, the UK, Spain or America—did too. World leaders, especially Obama, have failed to make adequately clear that sacrifices have to be made across the board.
In Europe, the strongest disciplinarians have been Britain’s David Cameron and Germany’s Angela Merkel. It is fashionable to criticize them. But the brickbats are largely misguided. Cameron is said to have gone in too hard with his austerity. But the UK has gained a lot of kudos with the markets by doing so. Would it really have been sensible for Britain to be soft when Ireland is blowing up on its border? Portugal and possibly Spain are in danger of being sucked into the vortex precisely because their governments have been slow to appreciate the gravity of the situation.
Meanwhile, Merkel has been criticized for being too harsh in setting the terms for Greece’s bailout—and for pushing the idea that, in the future, bondholders should face haircuts when governments are bailed out. The bondholder haircut idea could, admittedly, have been timed better, but it is still exactly the right principle. As for Greece, its feet had to be held to the fire before it would agree to fight corruption and root out decades of mismanagement.
Returning to Ireland, its bailout conditions have yet to be revealed. Another dose of conventional austerity—for example, reducing the minimum wage and welfare benefits—is probably called for. But from the perspective of fairness, the crying need is also to inflict as much pain as legally possible on bank creditors. That would be the right balance of bailout and punishment.