If debt forgiveness benefits both equity and debt holders, why do debt holders not voluntarily agree to it?
· First of all, there is a coordination problem.
Even if each individual debtholder benefits from a reduction in the face value of debt, she will benefit even more if everybody else cuts the face value of their debt and she does not. Hence, everybody waits for the other to move first, creating obvious delay.
· Second, from a debt holder point of view, a government bail-out is better.
Thus, any talk of a government bail-out reduces the debt-holders’ incentives to act, making the government bail-out more necessary.
As during the Great Depression and in many debt restructurings, it makes sense in the current contingency to mandate a partial debt forgiveness or a debt-for-equity swap in the financial sector. It has the benefit of being a well-tested strategy in the private sector and it leaves the taxpayers out of the picture.
But if it is so simple, why has no expert mentioned it?
Taxing the many to benefits the few
The major players in the financial sector do not like it. It is much more appealing for the financial industry to be bailed out at taxpayers’ expense than to bear their share of pain. Forcing a debt-for-equity swap or a debt-forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition. The appeal of the Paulson solution is that it taxes the many and benefits the few. Since the many (we, the taxpayers) are dispersed, we cannot put up a good fight in Capitol Hill. The financial industry is well represented at all the levels. It is enough to say that for 6 of the last 13 years, the Secretary of Treasury was a Goldman Sachs alumnus. But, as financial experts, this silence is also our responsibility. Just as it is difficult to find a doctor willing to testify against another doctor in a malpractice suit, no matter how egregious the case, finance experts in both political parties are too friendly to the industry they study and work in.
Profits are private but losses are socialised?
The decisions that will be made this weekend matter not just to the prospects of the US economy in the year to come. They will shape the type of capitalism we will live in for the next fifty years. Do we want to live in a system where profits are private, but losses are socialised? Where taxpayer money is used to prop up failed firms? Or do we want to live in a system where people are held responsible for their decisions, where imprudent behavior is penalised and prudent behavior rewarded?
This article by Luigi Zingales explains very clearly why the financial sector is preventing the government from debt forgiveness (I removed some of the US connotations so that the Icelandic situation could be more easily understood) :
If debt forgiveness benefits both equity and debt holders, why do debt holders not voluntarily agree to it?
· First of all, there is a coordination problem.
Even if each individual debtholder benefits from a reduction in the face value of debt, she will benefit even more if everybody else cuts the face value of their debt and she does not. Hence, everybody waits for the other to move first, creating obvious delay.
· Second, from a debt holder point of view, a government bail-out is better.
Thus, any talk of a government bail-out reduces the debt-holders’ incentives to act, making the government bail-out more necessary.
As during the Great Depression and in many debt restructurings, it makes sense in the current contingency to mandate a partial debt forgiveness or a debt-for-equity swap in the financial sector. It has the benefit of being a well-tested strategy in the private sector and it leaves the taxpayers out of the picture.
But if it is so simple, why has no expert mentioned it?
Taxing the many to benefits the few
The major players in the financial sector do not like it. It is much more appealing for the financial industry to be bailed out at taxpayers’ expense than to bear their share of pain. Forcing a debt-for-equity swap or a debt-forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition. But, as financial experts, this silence is also our responsibility. Just as it is difficult to find a doctor willing to testify against another doctor in a malpractice suit, no matter how egregious the case, finance experts in both political parties are too friendly to the industry they study and work in.
Profits are private but losses are socialised?
The decisions that will be made matter not just to the prospects of the economy in the year to come. They will shape the type of capitalism we will live in for the next fifty years. Do we want to live in a system where profits are private, but losses are socialised? Where taxpayer money is used to prop up failed firms? Or do we want to live in a system where people are held responsible for their decisions, where imprudent behavior is penalised and prudent behavior rewarded?
Related posts:
- The Zingales Plan’s Advantage
- The Zingales Plan
- Niall Ferguson on debt cancellation
- Iceland In Debt
- The Inept Government
Kjartan
2 years ago
“You read that the IMF bails out countries when they get into trouble, but that’s highly misleading. It doesn’t bail out the countries. It bails out the lenders and the investors, makes sure they don’t have to take a risk for their risky, and therefore high-yield, investments.”
-Noam Chomsky, February 2000
D_Boone
2 years ago
Now that government level debt restructuring is near complete private debt restructuring SHOULD be top priority. It appears their are many dead canards that need attention: loan indexing, foreign currency loans, bankruptcy laws, and efficient restructuring of debt and equity. I also get the feeling though that Icelanders are getting tired of it all.
D_Boone
2 years ago
Of course each country responds differently to similar events.
http://www.stuff.co.nz/business/3106541/Angry-investors-rough-up-Bridgecorp-boss