Steve Randy Waldman has a great post explaining why for banks more so than for most firms accounting is destiny. That’s because what a bank is allowed to do depends in great deal on its accounting status, and what it’s allowed to do has real impacts on various stakeholders:
Whether or not a bank takes a capital hit has no bearing on whether a principal reduction will increase the realizable cash-flow value of the loan.
But accounting is destiny. The economic value of a bank franchise, both to shareholders and managers, is intimately wound up with its accounting position. A bank whose books are healthy may distribute cash to shareholders and managers, while a bank whose capital position has deteriorated will find itself constrained. A well-capitalized bank is free to take on lucrative, speculative new business, while a troubled bank must remain boringly and unprofitably vanilla. The option to distribute and the option to speculate have extraordinary economic value to bank shareholders and managers.
Consequently, there can be principle write-downs that have no impact on the realizable cash-flow value of loans that it would be socially beneficial to undertake but still contrary to the interests of bank managers and bank owners.
Read the whole post for the full argument. But this is an important reminder that throughout the crisis, political discussion has failed to adequately distinguish between banks, bank managers, and bank owners. A policy that looks at a trouble bank, forces full write-downs of bad loans, injects taxpayer capital to make the bank sound again, and then reprivatizes the newly healthy bank is very friendly to the bank qua brand. There may be a huge “bailout” that involves a vast sum of taxpayer money going “to the bank.” At the same time, such a process of nationalization and re-privatization would likely involve all the bank’s top executives getting fired. It would involve the pre-nationalization equity owners of the bank losing their shirts. By contrast, a policy that refused to deliver the bailout but instead offered wink-nod regulation could allow the bank to recapitalize through profits. This policy is worse “for the bank,” but it’s much better for the CEO of the bank. When the story of the Little Depression is written, I think we’ll see that ironically bailout backlash has proven to be cover for harmful policies that serve the interest of bankers.