Thursday, January 1, 2009
Hans-Werner Sinn Gets It
"Now that the countries of the west have agreed to a three-trillion dollar bailout programme to rescue their banking systems, it is time to look forward and to draw lessons from the crisis. To do this we must understand the causes of the crisis. ... The core of the crisis lies in the legal provisions of limited liability. Creditors of corporations have no claims against the personal assets of the owners (shareholders) of these corporations. ... In times of great economic insecurity, however, limiting liability can become a problem because it induces entrepreneurs to become gamblers. ... The risks created incentives to minimise the stock of equity kept inside these firms, and the small amount of equity capital in turn created incentives to pursue overly risky operations. The interplay of these incentives is the actual cause of the crisis--and this is where reform must begin. The privilege of limited liabilty is not a creation of the market. ... Politicians must finally face the task of defining legal liability limitations for corporations by establishing strict minimum standards for equity capital requirement for the various business models of the banks, both in America and in Europe", my emphasis, Hans-Werner Sinn, 17 December 2008 at http://www.voxeu.org/index.php?q=node/2701.
I agree with Sinn, a University of Munich professor, but think his remedy unworkable as the system will be gamed and publicly-traded companies shares would in effect, be traded with "coupons attached". How do you attribute liability to a shareholder who owned his 100 shares for three days of the company with nine billion shares outstanding? Assume you make a three-year "fraudulent transfer" search. Should the 100 share shareholder be liable for 300 / 9,855 billion of the company's liabilities (9 billion x 365 x 3)? Should you bring hundreds of thousands of shareholders into the bankruptcy? I proposed making officers of companies liable up to three times each's last three years' compensation. In effect, making publicly-traded companies limited partnerships.