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Rogoff: Stop the financial bleeding
Solution will include accelerated bankruptcy for some financial institutions
When you have a recession associated with a financial crisis, you don't get better unless you fix the financial system. The medical analogy is giving transfusions to a patient who's hemorrhaging. If you don't fix the hemorrhage, you can put in all the blood you want.
Step one is to accept reality. We need to put most of the major financial institutions through accelerated bankruptcy. We're not going to get normal lending until we do that. We also need to lay down a regulatory framework so this doesn't happen again. Firms can't be allowed to borrow short-term debt way beyond their capital. The banks that come out of bankruptcy will have to obey this.
It's not that it won't cost a lot of money. The hole in the US financial system is something like $2 trillion. But the worst of all worlds is where the taxpayer puts in $1 trillion and it doesn't get the job done. Meanwhile, the management and regulatory system that created the mess remain in place, and we just keep bleeding.
The core elements of bankruptcy are stockholders get wiped out, bond holders who loaned money get less than they're owed, and the senior management and the board of directors get fired. In this case, the government would probably have to put money into the banks, retaining stakes for a while, but selling them down the road. At the end of process, you'd have banks like we have now, maybe with the same names. Most of the employees would still be there.
I don't pretend that this is going to be pretty. It could make the recession worse this year. But if we don't do this, we're looking at drifting in and out of recession for 10 years.
Kenneth Rogoff is a professor of economics at Harvard University and former chief economist at the International Monetary Fund.
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