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.