“If debtors cannot repay, creditors should bear the losses,” Sinn argues in an op-ed in yesterday’s New York Times. He further states that “It is unfair for critics to ask Germany to bear even more risk” in helping to resolve problems in Europe.
What Sinn presents is a neat ethical dream in which all parties are held responsible for their actions. The trouble is this dream does not face up to political reality. Spillovers between the intertwined Systemically Important Financial Institutions (SIFI) mean that the implementation of Sinn’s ethical dream would create a real-world nightmare. You cannot simply let everyone go bust until you have figured out how to design and implement a financial regulatory system that can deal with the problem these SIFI represent.
Make no mistake, banks should bear losses. But in economics, luminaries such as Mancur Olson in hisThe Logic of Collective Action explain what outcomes the realpolitik will create.
Olson tells us that the structure of politics and regulatory capture leads to a result that shifts the burden away from financial institutions and toward the weaker political entities.
His conclusions are backed up by history. Just look at what happened during the crisis in Latin America from 1982 to 1989, the 1994 crisis in Mexico, the U.S. mortgage crisis, and now the euro zone crisis.
(Sinn also gets his history wrong in his example of the U.S. socializing debt. Read here to understand what really happened and how it demonstrates the exact opposite of what Sinn is advocating.)
In addition, while Sinn points a finger at deficit nations, he neglects to mention how Germany benefited from these nations absorbing Germany’s trade surplus during the burdensome adjustment to unification. (Felix Salmon also suggests that Sinn greatly exaggerates what German taxpayers owe Europe.) Has the euro not served Germany exceedingly well? If so, then isn’t it time for Germany to recycle some of those benefits throughout Europe? Taken in full context, the answer to Sinn’s question, “Why is that not enough?” is obvious. And Sinn’s ethical straw man seems at best irrelevant – and at worst willfully unaware.
In theory, Sinn’s ethical dream should be applauded. Creditors should pay for their losses if the market is to function correctly. In context, however, his call for responsibility in this time of financial peril is only reasonable if the architecture is in place to deliver his dreams without systemic collapse – and if Germany also is held responsible for its actions leading up to the crisis. But if Germany were to simply take his advice, the results would be downright Sinnful.