Dear Financial Regulator, Elected Lawmaker, Or State Appointed Technocrat,
Congratulations! If you’ve opened this guide to preventing a financial meltdown, then you’ve already taken the most difficult step – admitting you have a problem.
The majority of financial debacles are due to complacency, political infighting, or some distraction – a war, say – that diverts attention or at least confuses priorities.
But by giving your Potentially Cascading Financial Implosion the attention it deserves, you have the best chance of putting out the fire before it gets going.
Indeed, you can already look forward with confidence to getting blamed for overreacting when you’re done.
Promise to do “whatever it takes”
The number one rule is to act like the coolest 14-year old you knew from school.
Be insanely ambitious and act with totally unwarranted confidence.
Okay, that’s two rules, but nobody will be counting right now.
Ambition: there is no point totting up what you think is the most likely scenario and sending out a cheque drawn up to two decimal places. Not when everyone else is operating according to the worse-case scenario and panicking. Whatever you think it will take – funding, legislation, sticking to the small print, number of acronyms, or political grandstanding – double it. Then double it again.
If you promise to drown the market in liquidity, then you probably won’t need to.
Confidence: financial crises are nearly always caused by a loss of faith, whether in asset values, institutions, currencies, regulators, or governments. Sometimes the doubt is warranted, occasionally not. Either way, do all you can to convince market participants that you have control of the situation.
Fake it until you make it.
The three-step process
Firstly, protect the masses – especially if they can move their money.
In the case of a banking crisis, you must act immediately to convince people that they will not lose money, whatever they do. Especially if they do nothing.
Bank runs are quite logical when people fear others will get their money out before them – the “It’s not panicking when you’re first out of the door” principle.
Make sweeping guarantees to protect everything. It’ll be cheaper in the long run.
Secondly, amputate and cauterise.
Don’t spend weeks paying teams of consultants to create complicated rescue plans part-funded by a consortium of Sovereign Wealth Funds, where taxpayers will see some of the upside in return for taking on the risk.
Yes, we saw where your head was going.
By the time you’ve formalised your plan, survivors might be melting down ATM machines to make Iron Age weapons.
Decide where the rot is worst and shut it down. Use all the powers at your disposal to seize control, fire the executives, and wipe out the shareholders.
You’ll probably have to throw bondholders a bone – to avoid things getting even worse – but everyone knows equity is toast in an endgame. So toast it fast and see them in court later. Your sole aim is to stop the contagion spreading.
Thirdly, get weak businesses into strong hands.
You don’t need to worry if shareholders get mullered or if the good leaders get thrown out with the bad. It might not be fair, but it’s better than a meltdown.
However, if you’re following this guide, then you probably do need to care – quite a lot – should the underlying businesses suddenly stop functioning.
Chances are near-100% that your Potential Financial Crisis has not been caused by a nail salon running out of pink lacquer or a fantasy football app being bankrupted by Accrington Stanley winning at Barcelona 27-0.
No, you’ll be dealing with insurers, banks, clearing houses, pension providers, and other scarily vital institutions. When these businesses stop functioning, others can’t pay their staff or roll over contracts. That’s Very Bad!
Look around, though, and you’ll soon spot healthy Too Big To Fail institutions that can swallow these broken-down businesses and keep the lights on – literally.
Make them an offer they can’t refuse to take what they will off your hands.
These simple steps will prevent the majority of financial crises becoming the next Great Depression. But every disaster is different.
Often you will find the sickness metastasising or certain aspects of the medicine being rejected by the patient – or refused the public.
Moral hazard fever – this typically emerges after you deliver universal protections that weren’t previously enshrined in law or contract. For instance, guaranteeing system-wide deposits held with regulated entities will stick in some craws. And yes, it really is letting risk-taking depositors and institutions off the hook, and so implicitly penalises those who adhered to the rules. But you know what’s worse than moral hazard? A Great Depression. Act as you must, and try to be tough when you beef up the rules after the crisis has passed, and nobody cares anymore.
Secondary infection – it’s very possible your actions will cause new problems. For example, if you slash interest rates that were universally expected to rise, that will leave many active traders carrying the baby. You might let hedge funds implode without shedding a tear, but we guarantee some local authority or public servants’ benevolent fund will have given them half their assets to manage. Put your gloves back on and plunge in as you must.
Market vigilantes – traders may doubt your resolve and test you by going after the weakest survivors of your cull. This is a normal and common side effect. It means you were either too soft-hearted when you did your cull, or else you weren’t ambitious enough when you announced your liquidity programmes. Review steps one to three above, while imagining how well your sensitive, musical instrument-playing children would fare in post-capitalist Mad Max wasteland. Then add a zero to every number in your rescue package.
Obstinate giants – there’s always that one Too Big To Fail institution that refuses to play ball. Typically they cite moral hazard, or perhaps a fiduciary duty to their shareholders. But really they know they are Too Big To Fail and believe they can get away with murder. Bring them onside by making their leaders think the rescue plan was their idea. If that doesn’t work, convince them they’re getting something cheap from your carve-ups. If they still protest, legislate to force all relevant firms to take part together, at pain of losing access to – oh, who knows – central banking facilities or their licenses.
Remember: it’s your world. They just live in it.
Good luck and godspeed
What are you waiting for? Time is of the essence. While you’ve been reading this, the fire has been spreading.
Do what you have to and make your excuses later.
It’s not your fault that your predecessors were too sloppy. It’s also not your fault that your successors will cave to lobbying and weaken whatever remedial measures are put in place to make sure this “never happens again”. It will certainly happen again. So fold this guide up neatly when you’re done and pop it back in the box for next time.