The terrible idea of criminalizing bank failure has been defended as a kind of shareholder protection plan. But this raises the question: do shareholders want to be protected from risk taking bankers? I think the answer is clearly “NO.”
Every time a major financial institution fails we hear about shareholders being “wiped out.” Indeed, when the Guardian’s Paul Collier proposed making “bankslaughter” a crime, one of his reasons was to punish bank executives for “wiping out… shareholders.”
But this is nonsense. Shareholders aren’t wiped out when a bank fails. Instead, what’s wiped out is the portion of their investment portfolio that is composed of shares in that particular bank. When Northern Rock or Lehman Brother or Bear Stearns failed, those shares got clobbered or even rendered valueless. But very few investors had all or even a substantial portion of their investment portfolio invested in only those stocks. And those few who did tended to be the executives actually running the banks.
Most investors are far more diversified than the “wipe out” analysis implies. Sure, they may not have a perfectly diversified portfolio. But, apart from the exeuctives running the place, only the most reckless gamblers put their entire nest egg in Lehman Brothers. Instead, diversified investors put a portion of their funds into banks.
And this points to a major problem with imagining we would be protecting shareholders by criminalizing bank failure–the shareholders don’t want to be protected. Indeed, they want bank managers to take on enormous risks. If anything, the problem is that they want bank managers to take on too much risk, betting that they’ll be bailed out if things go badly.
We can know for a certainty that shareholders aren’t seeking protection from reckless bankers. The evidence is right before our eyes and completely obvious. And here it is: they bought shares in bank stocks. They actively sought exposure to risk taking bankers, diverting money from less risky sectors to a more risky sector.
When I first heard of this idea, I wondered if one way of dealing with it would be to allow bank shareholders to vote on whether they wanted to be protected by “bankslaughter” laws. I was certain that almost all such shareholder votes would fail, because shareholders don’t want this kind of protection. But then I realised that shareholders already have a perfectly functional way of voting against exposure to risk taking bankers. If they want protection they don’t need new criminal laws. They can sell their stocks.
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