Fed's Irresponsible Stress Tests

Moneybox
A blog about business and economics.
March 14 2013 5:18 PM

The Real Bank Bailout Is Happening Right Now

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WASHINGTON, DC - FEBRUARY 27: Federal Reserve Board Chairman Ben Bernanke takes a drink of water while testifing before a House Financial Services Committee, on Capitol Hill, February 27, 2013 in Washington, DC.

Photo by Mark Wilson/Getty Images

The Federal Reserve today gave the green light to the overwhelming majority of large bank plans to pay dividends or engage in share buybacks. People are going to gloss over this story as no big thing of interest to anyone other than dedicated investors, but in fact this right here is the real bank bailout.

Proposals that banks be forced to finance more of their activity with equity are invariably met with the response that this would decrease lending activity. But you see right here today that this is a fallacy. These banks are earning profits. And like any other company they could use these profits to fund new equity-funded investments or to pay off old loans. Either way there'd be bank deleveraging and no decline in the amount of credit available to the economy. But instead they're using the profits to return cash to shareholders. And it's here when the bank is profitable and doesn't need a "bailout" that the grift takes place. While the market's on an upswing, you tunnel money out of the firm leaving it overleveraged and exposed to failure in a downswing. Even if you wipe the equity owners out when the failure happens, they'll still have made money during the fat years and the executives will still have gotten paid.

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The time to stop the cycle is during the good times. Keep the profits inside the firm until the banks are sufficiently well-capitalized as to be really unlikely to fail even if things get bad. Then if a bad market causes huge bank losses, there's no need for a bailout. You just re-impose the no-dividend/no-buybacks rule until the bank is well-capitlized again.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.

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