Tyler Cowen and Big Banks

Tyler Cowen has an excellent piece in today's NYT. It's the best idea I have heard in a long time about altering the incentives of banks in a good way. As with most good ideas, it's simple:

There is a better alternative [to other approaches to regulating bad behavior]: expanding the liability for major financial institutions. If a shareholder invests a dollar in a big bank, why not make that shareholder liable for the first $1.50 — or more — of losses as insolvency approaches? In essence, we would be making the shareholders liable for the costs that bank failures impose on society, and making the banks sort out the right mixes of activities and risks.

This idea is not new. Indeed, the early 19th century Scottish banking system had unlimited liability, and there were double liability provisions in early Canadian banking. That's not really a coincidence, as the early Canadian bankers were in fact Scots. As is well known to historians, the 19th century Scottish banking system, and the Canadian banking system (in the 19th, 20th, and 21st centuries), were successes, which is obviously important.

For references, first from my Google search, see this World Bank working paper, and this 1937 AER paper. From my archive, read this and this, and this.

One last point. You might wonder how you get the shareholders to pay up on the extended liability provisions. That's easy. They post collateral.