Central bank digital currencies
13 January 2021
Erasmus and Turing
11 January 2021
Brexit and Marxism
3 January 2021
What to do about the Covid financial system bailouts?
22 December 2020
The crypto-technical response to the Covid-19 bailouts
13 December 2020
The libertarian response to the Covid-19 financial turmoil
9 December 2020
The socialist response to the Covid-19 financial turmoil
4 December 2020
On the response of the financial authorities to Covid-19
2 December 2020
The Covid-19 bailouts and the future of the capitalist banking system
26 November 2020
Which programming language is best for economic research: Julia, Matlab, Python or R?
20 August 2020
ARM on AWS for R
15 June 2020
Low vol strategies
8 May 2020
Of Julia and R
8 May 2020
How to manipulate risk forecasts 101
30 April 2020
The five principles of correct riskometer use
27 April 2020
The problem with Backtesting
25 April 2020
The magic of riskometers
24 April 2020
Risk and scientific socialism
23 April 2020
Financial crises and epidemics
19 April 2020
Hayek and Corona
17 April 2020
Hayek et Corona
17 April 2020
Ignoring the Corona analysis
15 April 2020
The coronavirus crisis is no 2008
26 March 2020
Artificial intelligence as a central banker
6 March 2020
Systemic consequences of outsourcing to the cloud
2 December 2019
The dissonance of the short and long term
12 August 2019
Central banks and reputation risk
6 August 2019
The Brexit culture war
5 May 2019
All about BoB — The Bank of England Bot
29 April 2019
My tiny, tiny contribution to Apple's fall in profits
6 January 2019
The 2018 market in a 250 year context
1 January 2019
Short and long-term risk
3 December 2018
Perceived and actual risk
2 December 2018
Cryptocurrencies: Financial stability and fairness
9 November 2018
The October 2018 stock market in a historical context
1 November 2018
The hierarchy of financial policies
12 September 2018
Which numerical computing language is best: Julia, MATLAB, Python or R?
9 July 2018
26 June 2018
What are risk models good for?
3 June 2018
The McNamara fallacy in financial policymaking
1 June 2018
VIX, CISS and all the political uncertainty
20 May 2018
Here be dragons
30 March 2018
Low risk as a predictor of financial crises
26 March 2018
Cryptocurrencies don't make sense
13 February 2018
Yesterday's mini crash in a historical context
6 February 2018
Artificial intelligence and the stability of markets
15 November 2017
European bank-sovereign doom loop
30 September 2017
Do the new financial regulations favour the largest banks?
27 September 2017
The ECB Systemic Risk Indicator
24 September 2017
Finance is not engineering
22 September 2017
University of Iceland seminar
14 June 2017
Brexit and systemic risk
31 May 2017
Should macroprudential policy target real estate prices?
12 May 2017
Learning from history at LQG
13 April 2017
Is Julia ready for prime time?
12 March 2017
With capital controls gone, Iceland must prioritise investing abroad
12 March 2017
Competing Brexit visions
25 February 2017
Systemic consequences of Brexit
23 February 2017
Why macropru can end up being procyclical
15 December 2016
The fatal flaw in macropru: It ignores political risk
8 December 2016
Why it doesn't make sense to hold bonds
27 June 2016
On the financial market consequences of Brexit
24 June 2016
Cyber risk as systemic risk
10 June 2016
Big Banks' Risk Does Not Compute
24 May 2016
Interview on þjóðbraut on Hringbraut
21 May 2016
Farewell CoCos
26 April 2016
Will Brexit give us the 1950s or Hong Kong?
18 April 2016
Of Brexit and regulations
16 April 2016
IMF and Iceland
12 April 2016
Stability in Iceland
7 April 2016
Everybody right, everybody wrong: Plural rationalities in macroprudential regulation
18 March 2016
Of tail risk
12 March 2016
Models and regulations and the political leadership
26 February 2016
Why do we rely so much on models when we know they can't be trusted?
25 February 2016
Does a true model exist and does it matter?
25 February 2016
The point of central banks
25 January 2016
Volatility, financial crises and Minsky's hypothesis
2 October 2015
Impact of the recent market turmoil on risk measures
28 August 2015
Iceland, Greece and political hectoring
13 August 2015
A proposed research and policy agenda for systemic risk
7 August 2015
Are asset managers systemically important?
5 August 2015
Objective function of macro-prudential regulations
24 July 2015
Risky business: Finding the balance between financial stability and risk
24 July 2015
Regulators could be responsible for next financial crash
21 July 2015
How Iceland is falling behind. On Sprengisandur
12 July 2015
Greece on Sprengisandur
12 July 2015
Why Iceland can now remove capital controls
11 June 2015
Market moves that are supposed to happen every half-decade keep happening
14 May 2015
Capital controls
12 May 2015
What do ES and VaR say about the tails
25 April 2015
Why risk is hard to measure
25 April 2015
Post-Crisis banking regulation: Evolution of economic thinking as it happened on Vox
2 March 2015
The Danish FX event
24 February 2015
On the Swiss FX shock
24 February 2015
Europe's proposed capital markets union
23 February 2015
What the Swiss FX shock says about risk models
18 January 2015
Model risk: Risk measures when models may be wrong
8 June 2014
The new market-risk regulations
28 November 2013
Solvency II: Three principles to respect
21 October 2013
Political challenges of the macroprudential agenda
6 September 2013
Iceland's post-Crisis economy: A myth or a miracle?
21 May 2013
The capital controls in Cyprus and the Icelandic experience
28 March 2013
Towards a more procyclical financial system
6 March 2013
Europe's pre-Eurozone debt crisis: Faroe Islands in the 1990s
11 September 2012
Countercyclical regulation in Solvency II: Merits and flaws
23 June 2012
The Greek crisis: When political desire triumphs economic reality
2 March 2012
Iceland and the IMF: Why the capital controls are entirely wrong
14 November 2011
Iceland: Was the IMF programme successful?
27 October 2011
How not to resolve a banking crisis: Learning from Iceland's mistakes
26 October 2011
Capital, politics and bank weaknesses
27 June 2011
The appropriate use of risk models: Part II
17 June 2011
The appropriate use of risk models: Part I
16 June 2011
Lessons from the Icesave rejection
27 April 2011
A prudential regulatory issue at the heart of Solvency II
31 March 2011
Valuing insurers' liabilities during crises: What EU policymakers should not do
18 March 2011
Risk and crises: How the models failed and are failing
18 February 2011
The saga of Icesave: A new CEPR Policy Insight
26 January 2010
Iceland applies for EU membership, the outcome is uncertain
21 July 2009
Bonus incensed
25 May 2009
Not so fast! There's no reason to regulate everything
25 March 2009
Modelling financial turmoil through endogenous risk
11 March 2009
Financial regulation built on sand: The myth of the riskometer
1 March 2009
Government failures in Iceland: Entranced by banking
9 February 2009
How bad could the crisis get? Lessons from Iceland
12 November 2008
Regulation and financial models: Complexity kills
29 September 2008
Blame the models
8 May 2008

The Covid-19 bailouts and the future of the capitalist banking system

26 November 2020

The central banks bailed out the financial system in March 2020, the second time they have done so in 12 years. What is the point of privately owned banks if they require a bailout every decade?

The financial system had gotten itself into such a state in 2008 that the financial authorities concluded that the only way to prevent another Great Depression was to bail out almost every financial institution in the world.

When Covid-19 came around, fearing a financial crisis, the authorities applied all the lessons they had learned from 2008. Nobody received a capital injection or got to sell their dodgy assets to the state. But the central banks did provide liquidity and lowered capital standards, both of which kept the financial system running as if nothing had happened. The banks would have been much worse of without the central bank support, and that support is not free — bailouts by another name, even if they did pass unseen, lost in all the Covid-19 hoopla.

Are we better off because of the Covid-19 bailouts?

In the conventional narrative, the banks did nothing wrong in 2020; they were just hit by a rather nasty exogenous demand shock and had to be supported. The turmoil wasn’t their fault, and the central banks rescued us from a financial crisis by correctly applying all the lessons learned from 2008. If central banks had reacted as decisively in 2008, that crisis would also have been averted.


Not quite.

The economy is hit by large shocks all the time, but we don’t bail out most privately owned firms — responding to all the Covid-19 bankruptcies with “good luck with that”. The right answer. Privately owned firms enjoy the benefits of the upside and suffer the downside, the first principle of capitalism.

Not in finance. A big shock comes along, and the banks are bailed out.


Why let the banks get all the upside and then enjoy a bailout when things go pear-shaped?

The common view is that the financial authorities had no choice but to support the banks in 2008 and 2020. You see, banks are essential, and the costs of them failing vastly exceeds the cost of support, not the case for most other private firms. Correct when seen through the narrow lens of static economic analysis — what I once called Excelonomics. If a crisis is unique, a never to be repeated event, the cost of the crisis outweighs the cost of the bailout.

But that is simpleminded and bad economics.

A bailout creates moral hazard. Because the central banks bail the financial system out every time markets are disrupted — the Greenspan put — the financial institutions just take a lot more risk in the comforting knowledge that the central banks will step in to rescue them when the bets go wrong.

Once you start giving away money to a sector, it will find a way to expand its activities so as to increase the size of the cheques.

Meanwhile, all the “Whatever it takes” not only remain in place, but the financial authorities are proud of them.

The price of all the bailouts eventually exceeds the cost of the very few crises we would suffer if the banks were not tempted to take too much risk, as no support is forthcoming.

And there are serious consequences.

Crises empower the financial authorities, even if crises are partly a creature of their own making. The authorities now ask the right question, “what can we do to prevent a repeat” and come to the wrong answer, [“more regulations and more control”]((/blog/official-response-to-covid/). Transferring yet more responsibility for finance to the state.

The new regulations will not prevent future crises, but future crises will make the financial system more and more state controlled.

Then, we have the heavy pressure on the banks to provide credit to all the enterprises squeezed by Covid-19 — what economists call financial repression. The governments want the banks to do more and are looking for ways to force them to do that. Financial regulations help.

The state may find even more power in the newfangled central bank digital currencies, where savings are blocks on a central bank controlled blockchain and the central bank either directly allocates credit or franchises private institutions to do that on its behalf.

The bailouts, meanwhile, undermine the credibility of the state. If the financial authorities can do no better than a setup requiring a bailout every decade, neither the authorities nor the governments that empower them appear competent or honest.

Why do we condone the typical $50,000 a year family being forced to bail out the $250,000 a year banker?

Why do we accept financial policy sharply increasing inequality?

How can such a state offer a credible alternative to political extremism?

How can it be trusted not to abuse central bank digital currencies?

And now I get to the existential threat.

What is the point of a privately run financial system if the state has to bail it out every time things go wrong?

Why not just have the state run the financial system?

That would be the worst possible outcome. No matter how we dislike banks needing frequent state support, having the state either dictate how banks are run or even providing banking services is much much worse.

If we end up with a nationalised baking system or one that is lobotomised and run by the state, we can only blame the financial sector for behaving in a way that makes it dependent on state support every decade and the financial authorities that make that support inevitable.

Then you may ask “Jon, fair enough, but what you propose?” I’m certainly no nihilist, but do allow me to leave the answer to more posts, listed below.



Several friends and colleagues have commented on this series. Robert Macrae and Nikola Tchouparov gave me excellent comments that significantly improved the pieces. We don’t always, or even usually, agree, and all opinions are mine alone.

© All rights reserved, Jon Danielsson, 2021