The British plan

as best I can make it out:

1. Buy equity in banks.

2. Guarantee interbank loans, for a fee.

3. Demand board seats.

4. Limit executive compensation.

The government reps on the boards can help limit the moral hazard problem that would otherwise arise from guaranteeing the debt of insolvent banks: their managers have strong incentives to take on lots of risk in hopes of returning to solvency, since being a whole lot bankrupt is no worse for the managers and shareholders than being a little bit bankrupt, but being slightly solvent is much, much better than being slightly insolvent.

This contrasts with the Paulson plan, in which the government takes non-voting equity and doesn’t guarantee interbank borrowing (at least explicitly). I think the UK plan makes more sense, if those board reps can really rein in risk-taking.

The trick will be to set the guarantee fees. This is where the taxpayers can make out like a bandit. If people and businesses trust governments but not banks, then there’s revenue to be derived from the spread between the short-term guaranteed interest rate and the short-term non-guaranteed interest rate. It’s a variation on seigneurage.

I see no good argument for making a present of that spread to the shareholders of financial institutions, even if the government is one of those shareholders. Ideally, the fee wouldn’t be like the U.S. deposit insurance system, where all banks pay the same premium, but would be proportioned to the riskiness of the institution, perhaps as determined by default-swap pricing on banks’ borrowings from non-banks.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: