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Wednesday, February 26, 2014

Constitutional Amendments 19 Banking Liability

     Limited liability companies are one of the social inventions that made entrepreneurialism possible. By limiting the liability of shareholders to their investment it became practical for large ventures that few individuals were able to afford possible. By comparison in partnerships every partner is liable for all the losses another partner makes. So long as those trading with them knows it is a limited liability company, which is why it is a legal requirement companies use the term "ltd" on correspondence, they know the risk they run.

     However banking is a different matter. Banks have to be big to be stable (though probably not "to big to fail"). However currently banks own your money as an asset & their debt to you is a liability so if they go bust you will, by definition get only so much in the £ back, or would if governments didn't bail them out. Worse than that, because it is limited liability, the managers can walk away or even, as the Fred Goodwin case showed, keep their pensions or assets which have been removed from the bank before it collapsed. This creates what is known as a moral hazard - that there is an incentive to take unjustified risks because the benefits of risks go to the managers, in the form of bonuses and promotions, but the costs are borne by society.

    So I think we should at least roll back the limitations on liability for those looking after people's money.

      Dan Hannan suggests this:

      reform would be the one backed by Steve Baker MP and the Cobden Centre, which is being introduced on Wednesday as a Ten Minute Rule Bill by the leader of Direct Democracy's Westminster wing, Douglas Carswell. Essentially, Douglas wants to amend the law so that depositors remain the owners of the money which they place in bank accounts. Currently, contrary to widespread belief, such assets are legally the property of the bank. Douglas's reform is to be recommended on several grounds: as a consumer protection measure; as a way of removing a peculiar legal exemption enjoyed by banks, but by no other businesses; as a prophylactic against the credit booms that precede recessions.
     The major, still current, example of a massive unlimited liability financial organisation is the Lloyds insurance organisation, which did indeed go bust some time ago and a number of Lloyds "names" (people who have guaranteed their assets for a share of the business profits) did indeed lose heavily, but the organisation survived.

      I'm agnostic as to how far we should go in increasing bank liability - having deposited money remain the property of the depositors so that in the event of failure they get it first/ making directors of banks financially liable for losses/ making shareholders (actually partners) liable up to a set value per share/ making them liable to an unlimited extent - but any of these steps would act as a greater or lesser discouragement of the moral hazard of casino banking and encouragement to fiscal conservatism by those responsible for people's deposits.

     In turn this would be negative feedback to the sort of boom and bust cycles we have recently seen.

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