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Maastricht and Bailouts

November 8, 2011

This site strongly advocates reforms that prevent asset bubbles and hence the need to pick up the pieces. However in view of the Eurozone crisis it would appear that there will be sovereign defaults; banks will suffer further losses and may need to be helped. In particular they may need recapitalisation (a.k.a ‘bailouts’).

Initially the US Troubled Assets Relief Program (TARP) involved the government buying ‘toxic assets’, but it was soon realised that buying newly issued equity was better in that it solved the problem of how to value the toxic assets and involved less ‘moral hazard’ in that existing stock holders would bear some of the cost in terms of dilution of stock (share) value. This was the scheme adopted in the UK. All this has involved governments borrowing money to fund the purchase of the the equity. Although assuming the scheme works, governemnts are able later to sell the stock (shares), in the meantime they will have been paying extra interest.

An alternative source of the money to buy the equity would be for the central bank to ‘print’ it as is done in Quantitative Easing (q.v.). The trouble is that according to the New Economics Foundation, the Maastricht Treaty prevents this [NEF 2011, p77 et. seq.]. Whereas it was reasonable in order to prepare for monetary union to prevent governments from funding current consumption by having money ‘printed’, it seems utterly unreasonable to prevent ‘printing’ of money to recapitalise banks, provided that the money is then ‘retired’ when the government then sells the shares. This would surely not be inflationary. The ECB has apparently treated this ‘flexibly’ in the light of the crisis. I have contacted the Treasury to clarify this but have received no response.

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