August 18, 2008 | posted by Michael Baxter in Banking |

Failure surely is the price we pay for our errors. If we don’t pay a price, then what incentive do we have not to repeat those errors?

Now former Fed chairman Alan Grenspan has entered the debate.

Mr Greenspan told a US newspaper that the Fed and the Treasury “should have wiped out the shareholders, nationalised the institutions with legislation that they are to be reconstituted as five or 10 individual privately-held units,” which would eventually be sold off.

It is a tad ironic. While at the Fed Mr Greenspan didn’t actually do the bail out, but he did orchestrate a rescue of Long Term Capital Management, so that the hedge fund that messed up so spectacularly never actually went bankrupt.

Maybe it was because US banks never actually suffered sufficiently for their recklessness in the mid 1990s, that they went on to repeat the same mistakes this decade.

But at least Northern Rock did actually fail in the end. The UK government did receive all kinds of flak for the Northern Rock debacle, but surely some kind of bail out, preserving the bank, would have sent an awful message to the other banks.

History tells us that the failure of banks can have a catastrophic effect upon the economy.

The economic depression in the US of the 1930s was partly the result of mass banking failure. More recently, Sweden, for example, suffered a major banking crisis in 1991 – and the cost to the economy – 6 per cent of GDP; further back in 1987 it was Norway that was struck, and the cost – 8 per cent of GDP. But in 1997, it was Spain which felt the horror of a full-scale banking crisis – and the cost, 16 per cent of GDP. Examples of other major banking crises include France (1994), Germany (1977), Japan (1992), the US (1984), but top of the order comes the UK (1974, 1991 and 1995). (data supplied by NIESR 2008.)

But things go in circles. Bank failure has in the past caused economic crisis. Maybe, this time around, not enough banking failure has caused this crisis.