Government bailouts of big banks are here to stay and are bad for economies because they channel capital to uncompetitive industries and sustain high levels of debt, according to a professor of economics and capitalism.
“Economies where the banks are really influenced by their governments just tend to have worse futures,” Garett Jones, Senior Scholar of George Mason University’s Mercatus Center, told CNBC Asia’s “Squawk Box” on Wednesday.
“We (economists) always treated bank bailouts as an emergency ripcord but it’s turned out to be just a constant diet for the rich countries. And I think that’s something that’s going to stick with us for a long time. Bailouts, especially bank bailouts, are forever.”
Bailouts along the lines of the U.S. government’s aid to the big U.S. banks in 2008 and 2009 create high levels of debt and permit industries to make unwise choices because they know they can rely on the state to get them out of immediate trouble, Jones added.
“The sectors that have failed are those that have implicit or explicit government backing, so capitalism makes big mistakes but to make the whoppers, it helps to have a government guarantee,” he said.
Spain on Monday became the latest nation to ask for aid from its European Union partners to prop up its banks, as Moody's Investors Service downgraded the ratings of 28 of 33 rated Spanish banks on the same day. This follows a cut to Spain's sovereign rating to just above junk status earlier this month, pushing Spain's country risk, as measured by the spread between German and Spanish benchmark bonds, to around 518 basis points.
Cyprus also sought emergency funding from Europe, the fifth economy in the region to do so, and may need a bailout of up to 10 billion euros ($12.5 billion), over half the size of its economy.
This constant bailout only serves to keep debt high and prolong weakness in economies and companies, Jones said.
“The levels of debt we saw, usually government-backed debt, whether officially or unofficially, all this debt is a big problem,” he said. “(Federal Reserve Chairman) Ben Bernanke’s research showed that high levels of debt can really cripple an economy and we have seen that over the last 4 years.”
Reforms are what are needed to get the world away from a cycle of bailouts, he said, proposing that banks convert their “vast amounts of long-term debt” into equity.
Investors need to take so-called ‘haircuts’ in their holdings, but political inertia is in the way.
“The rich-country bureaucrats have tried to come up with some kind of middle ground, what I would call speed bankruptcy , where you can tell the bondholders over the course of a weekend, hey guys, you are going to get 80 cents on the dollar, you’re going to get 60 cents on the dollar,” Jones added.
“But legally that’s been difficult and politically, politicians have been reluctant to push the button on this. The day of speed bankruptcy is always 5 to 10 years down the future,” he said.
- By CNBC's Jean Chua.