A Contractual Solution to the Credit Crunch no comments
The credit crunch is a simple tragedy of the commons. It is in each bank’s individual self interest to wait and see if the other institutions begin lending again. Why stick your neck out? Collectively the result is that no one lends. You need a big dog to come in and change the incentives for the major players to begin lending again.
The Fed and should write up a contract and send it to fifty of the world’s largest banks and financial institutions. The contract will specify a simple lending schedule; a ramp-up of lending over time by the institutions proportional to their size and holdings.
The contract’s obligations will kick in only if a certain threshold of the institutions sign, say 45 of the 50. It is a conditional contract. In the contract it states that the lending plan becomes obligatory only if 44 other institutions also sign. So, each institution can sign and know they are bound to begin lending only if most of the others are. Nobody is caught exposed. Nobody sticks their neck out.
Institutions that do not sign will lose access to the world central banks for say, ten years. Institutions that sign on but are later found to have violated the terms will have the same penalty applied. This solution is simple, effective and doesn’t involve bailouts or public ownership of banks.