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Frederic Mishkin, the Alfred Lerner Professor of Finance and Asset Management, speaks as part of Columbia Business School's ongoing series geared to address the community's concerns about the current economic crisis. Dean Hubbard moderates the discussion about the challenges ahead.
Professor Mishkin returns to Columbia Business School after serving on the Board of Governors of the Federal Reserve System. He brings to Columbia Business School a deep understanding of the current financial situation and the federal government's approach to solving it.
Frederic S. Mishkin is the Alfred Lerner Professor of Banking and Financial Institutions at the Graduate School of Business, Columbia University.
He is also a Research Associate at the National Bureau of Economic Research, and from September 2006 to August 2008 was a member (governor) of the Board of Governors of the Federal Reserve System. He has also been a Senior Fellow at the FDIC Center for Banking Research, and past President of the Eastern Economic Association.
Since receiving his Ph.D. from the Massachusetts Institute of Technology in 1976, he has taught at the University of Chicago, Northwestern University, Princeton University and Columbia. He has also received an honorary professorship from the Peoples (Renmin) University of China.
From 1994 to 1997 he was Executive Vice President and Director of Research at the Federal Reserve Bank of New York and an associate economist of the Federal Open Market Committee of the Federal Reserve System.
I realise I'm talking to myself here, but I just wanted to add this: A bail-in (instead of a bail-out) of the creditors as described above would have strengthened the capitalist system in many ways.
For one, it would in one stroke have solved the moral hazard problem that now seems so insurmountable.
It would also have signalled a commitment to the free market system that has produced so much wealth in the West already. Note that at the same time I advocate stronger regulation to prevent market failures and lessen their impact when they do happen. What we risk ending up with now is an understandable populist backlash against the capitalist system and reduced economic efficiency exactly when we need economic growth the most.
A further benefit of a bail-in would have been that foreign (quasi-)sovereign creditors would have learned that there is a risk to a trade surplus reliant on undervalued currencies. Or in an alternate but equivalent statement, a vendor assumes a risk when he finances the deficit of an extended consumer: If the debtor can't afford to repay the debt, he won't. In the case where the debtor is the US, this could in principle happen through US$ depreciation. But if that is not allowed to happen, then private sector bankruptcies should be allowed to find their way back to the creditors who financed the boom.
I realise this is an old video by now. I stumbled on it while I was browsing after being introduced to fora.tv today. After watching the video (and in case it might still get picked up by someone), I want to make just one comment on what I think is an inconsistency--in the speech, but unfortunately also in the crisis management in 2007-2009 by policy makers:
In response to a question, Prof. Mishkin said: "Too big to fail will always be there". I feel that this does not sit well next to his claim earlier in the talk that a backlash against and rejection of the capitalist system now would relegate a lot of people unnecessarily to poverty for a long time (which I agree with).
A firm that cannot be allowed to fail is not operating in a capitalist system in my opinion. The issue is related to Prof. Mishkin's focus on the asset side of the banking system's balance sheet, and on the " too big " (and interconnected) part of the problem. The tools should have been in place (and should be put in place now) to allow a bank " to fail " in orderly way. This means that the creditors of the banks (on the liability side of their balance sheets) should have been forced to take a haircut on their claims so as to allow recapitalisation of the balance sheets without the need for new money from the taxpayers. A (crammed-down) bail-in instead of a bail-out!
Clearly I'm not talking about depositors. It makes perfect sense to insure depositors (possibly up to a limit amount). But there should not have been a need to bail out all the other creditors of the banks.
I realise there would have been concerns about investors holding the bank debt, in particular pension funds and important foreign creditors who were relied on to finance the US's current account deficit. But they would have received the new equity in the clean balance sheets in return for taking the haircut. And their other investments arguably would have suffered less, even if only for the reason that the US Treasury would have kept its powder dry for a more potent and more targeted fiscal stimulus (instead of TARP).
Furthermore, it is not a sign of a strong belief by policy makers in the capitalist system if they prefer to side-step the system when times get rough. This is simply the mirror image of the critique that has been directed at bankers who benefited from privatised profits, but wanted to socialize the losses when things went wrong.