Does economics say that "since firms and shareholders have the incentives to take care of themselves, regulators should let banks pay dividends if they want to"?
No. The incentives of taxpayers and shareholders are not alligned.
[A thread]
1/10
🐦🔗: https://n.respublicae.eu/lugaricano/status/1641912444711845888
The tax-payer put granted to banks means that if things go badly for a very large bank, the share price is unlikely to ever reach 0- the taxpayer will step in and recapitalize the bank.
Heads they win, tails we lose.
Yes, we, taxpayers, are the ultimate “loss absorbers."
3/10
🐦🔗: https://n.respublicae.eu/lugaricano/status/1641912447492579330
Hence by buying back shares, banks transfer wealth from taxpayers to shareholders.
Crucially, this cost is not reflected in market prices, but it is a real loss for society.
4/10
🐦🔗: https://n.respublicae.eu/lugaricano/status/1641912448658685954
This would be acceptable if the bank’s capital ratio, measured by the highest quality regulatory capital, common equity tier 1 (CET1) (essentially common stock and retained earnings), was a reliable indicator of its true financial health.
5/10
🐦🔗: https://n.respublicae.eu/lugaricano/status/1641912450252431361
But as the recent troubles of Credit Suisse have shown, CET1 is backward looking, and it is based on accounting rules that do not reflect the market value of assets and liabilities and can be misleading and overstated.
6/10
🐦🔗: https://n.respublicae.eu/lugaricano/status/1641912451418533889
Moreover, the denominator continues to exclude sovereign risks which were at the root of the last financial crisis.
Also, nothing in CET1 reflects the possibility of deposit outflows or higher funding costs.
7/10
🐦🔗: https://n.respublicae.eu/lugaricano/status/1641912453016563713
The SSM (EU regulator) and the other regulators should use their authority to announce a moratorium on dividend payments and share buybacks by banks until they have conducted a thorough investigation into their economic capital adequacy.
8/10
🐦🔗: https://n.respublicae.eu/lugaricano/status/1641912454170005505
This investigation should take into account the recent interest rate increases and the Credit Suisse failure, and use market-based or fair value estimates of assets and liabilities, as well as realistic scenarios of stress and contagion.
9/10
🐦🔗: https://n.respublicae.eu/lugaricano/status/1641912455390429186
Crucially, they must also aim to value realistically the deposit franchise.
Only after ensuring that the equity value of the banks is close to CET, so that banks have enough equity to withstand shocks and protect taxpayers from bailouts, should the moratorium be ended.
10/10
🐦🔗: https://n.respublicae.eu/lugaricano/status/1641912456590008321
Banks are not normal firms: shareholders of banks benefit from a special type of put option.
A put is a contract that gives the buyer the right to sell an asset at a fixed price within a certain period of time- allowing her to benefit from a drop in the asset’s price.
2/10
🐦🔗: https://n.respublicae.eu/lugaricano/status/1641912446251159556