Who Should Face the Music When the Banks Fail?

Over the last two years, we've all seen who do face the music when banks fail. It's the average people, the consumers and employees who see their income tank, their jobs disappear, and the prices of everyday products skyrocket. And most of us know that it's not fair. Average people, after all, are not usually the ones who made poor investments on a large scale or who set up a system that would be initially profitable but unsustainable in the long run.

Yet the people who did make those decisions aren't being held personally accountable for their actions. While they lost their investments and (sometimes) their bonuses, their overall net worth was not on the line. Many of the high-ranking people who helped cause the recent financial meltdown still have their mansions, private jets, and other trappings of wealth.

Is There Another Option?

James Grant thinks this is wrong. In an editorial for the Washington Post, the editor for Grant's Interest Rate Observer advocates holding wealthy bankers personally liable if their bank fails. All of their property would be available for auction if people lost money because of their investments and needed reimbursement. This wouldn't happen very often, though, because Grant thinks that having their own financial well-being on the line would be enough to motivate these people to make sound financial decisions aimed at keeping things running well for years to come.

Grant argues that this structure has worked before. It was the standard structure in America before the 1930s, when people had confidence in the financial system even though most of their investment's weren't insured. Brazil has recently instituted a similar policy, and their financial sector is more stable than it has been in years.

Would It Work?

Grant's is a nice thought. Even though the collected assets of most banks' controlling stockholders, senior officers, and directors wouldn't cover the losses sustained if their institutions failed, it would be nice to know that they were suffering at a level commensurate with the misery they've inflicted. But would it do more than that?

If Grant's thesis is correct and laws like this kept banks from failing, they would be worthwhile. However, they would serve their purpose only as long as they didn't have to be acted upon. They would function mostly to make the top financiers afraid. If the banks still failed, the people still wouldn't have recourse to enough money to make much of a difference in their suffering.

Would the catharsis of liquidating the assets of wealthy bankers upon the failure of their bank be worthwhile to you, even if the money didn't come close to reimbursing losses? What choice would you make?

Bonus: For other economics nerds out there, read another plan for forestalling future economic crises. What do you think?

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Guest's picture

When a bank fails, the FDIC performs an in-depth audit to discover the cause of the failure, then directors and officers responsible.   The people who run the banks already have their personal wealth on the line.

Guest's picture

errr....The FDIC sues the directors and officers responsible, if they find evidence of negligence or recklessness.

Sarah Winfrey's picture

Hmmm . . . I'll give you a "sort of" on that one. First, getting the FDIC to make a call for negligence has a reputation for being pretty difficult. Generally, when they have made that call, there has been some sort of malicious intent involved (though I define that relatively broadly). We'll see how it goes with the banks that have failed more recently--maybe the epidemic of bank failures will cause some changes in the process.

Secondly, their personal wealth isn't necessarily on the line even if the FDIC does make the "negligence" call. That involves some fairly convoluted procedures--it may or may not happen.

The bottom line is that average people, as a collective, face the burden even if the FDIC does, eventually, make this call and hold the bankers responsible. They're the ones who lose more and that loss is sustained whether or not the bankers are someday held responsible.

Guest's picture

How about we hold the Politicians liable for the bad laws that they pass, enabling much of what we have seen in the Finance Indsutry and the Housiing industry?

Blaming a businessman for taking adavantage of the loopholes the politicans have created is sort of misisng the crux of the issue, doesn't it?

Do you take any deductions on your income taxes?  If so, are you ready to be blamed for somethign when the politicans decide to meddle in your returns?



Guest's picture

In a perfect world, the bankers should take most of the blame and probably the consumer for not being vigilant enough.... then again the bankers should take all the blame bEcause there is no way of knowing when or how a bank fails. But this is a world where the interest of self preservation drives all the aspects of life and hoping the big fat greedy bankers are going to give up even a little of their billions for someone they will never ever meet and frankly dont care for is pushing the envelope alittle too much.

Guest's picture

You seem to be missing the point that the Bankers are simply following the rules that the politicans have laid out.  Please, put the blame where it belongs, unless of course, that goes againt the narrative you desire to follow.

The first person you might want to investigate is Chris Dodd, after that, a good anal probe of Barney Frank ought to clear up who is at fault here. 

Guest's picture

This article goes wrong in so many places. Most corporations carry a directors & officers (D&O) insurance policy that covers the event that directors & officers are successfully held liable in a suit for business decisions. The D&O policy pays for litigation costs and pays out $X in damages if the D&Os are held liable, thus the D&Os don't feel the monetary pinch themselves. Not to mention it would be worthless - most bank owners are worth millions while banks deal in billions - payout would be hover around 5-10% and be not worth the effort, unless this matter ended in a criminal punishment (i.e. jail time, not a mere fine for the corporation, which is how we hold corporations liable as they receive treatment as a person). There are already criminal penalties for fraud, a la Bernie Madoff.

Secondly, in the USA most jurisdictions have common law (and often statutory) rules to protect business judgment decisions, else corporate officers would be held accountable for every bad decision, and some decisions are only bad in hindsight. Most people don't intentionally try to run a company in the ground due to the benefit structure. There are notable exceptions to this, for which there are fraud rules (ENRON, Madoff, intentional arson for insurance proceeds, etc etc).

Guest's picture

I don't like the idea.  Let them fail like any other business.  Don't bail them out.  If my business fails, no government bailout is headed my way despite the job loss.

Consumers just need to make sure they have less than $250,000 in one bank which isn't that hard to do, I would hope.

Guest's picture

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Guest's picture

Agree with Kim - but in a different capacity.  Grant's idea tries to find a single scapegoat when there are many parties involved.

There are other ways to severely restrict future earnings or seek out punitive action, but the only way it would even make sense to attack personal earnings would be if you took back all of the income from that job from that bank which was run into the ground.

Guest's picture

I don't think it would really change anything.   I also don't think its needed.  Banks don't actually fail all that much and the FDIC works perfectly fine and is funded by the banks.

Holding the person in charge directly accountable wouldn't stop failures.   Small businesses are owned by individuals and if their business fails then the owner can easily lose everything.   Yet  this doesn't keep small businesses from failing pretty frequently.

Philip Brewer's picture

It used to be that bank shareholders were on the line—to a measured and predetermined amount—when the bank was in danger.

This was back in the days when stocks were more like bonds, and had a face value. If you owned $1000 worth of stock in Bank X, you could expect to bring home dividends during good times—several precent of $1000 every year.

During bad times, though, you were on the hook for an additional $1000, if the bank saw its capital reserves dwindle. If the board called for it, every shareholder was obliged to cough up an additional amount equal to the capital value of their current shareholdings.

That seems like a really good compromise, to me. It doesn't have the lottery aspect of having the government coming along after-the-fact and picking a few people who'd been doing the same thing as everyone else. It also lets corporations remain "limited liability," just the limit is potentially double your investment.

That would make shareholders keep a much closer eye on the board of directors, I expect.

Guest's picture

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Guest's picture

Asking bankers to take personal responsibility in terms of the taking of their assets is just plain wrong. Yes, they should be assessed on their performance and action take accordingly but liquidating their assets? I don't think so.