Kill bill, or face moral hazard

The National Assembly’s committee on national policy has ignored both legal principles and common sense by passing a special law to reimburse more victims of insolvent savings banks. This builds on the current law, which guarantees that victims can be reimbursed for up to 50 million won ($44,500), even if the financial company in question goes bankrupt. But amounts higher than this are not guaranteed. Subordinated bonds rank as high-return and high-risk investments that cannot be paid or compensated for unless other senior debts are fully paid by the issuer. But the committee has now rubber-stamped a law that will not only reimburse deposits above 50 million won, but also compensate for up to 55 percent of the subordinated debt issued by the insolvent savings banks. Moreover, the committee also passed a piece of legislation that will retroactively apply the same benefits to deposits and subordinated bonds in savings banks that were suspended from September 2008.

Ex post facto laws are usually forbidden in states that function according to a constitution. But the legislative committee claims that consumers and investors of the savings bank suffered losses due to bad management and poor oversight by the financial authorities. The management frittered away consumers’ money with its illegal and corrupt activities, and the government performed a substandard supervisory role. But that doesn’t justify a piece of legislation that could wreak havoc on the financial order. The state has already worked to protect financial consumers by establishing regulations that they were aware of before making deposits and investments in a financial company. The victims can be compensated using the personal wealth of the largest shareholders and managing executives. If sales of the subordinated bonds were imperfect, they can be resolved through dispute arbitration procedures.

The parliamentary committee pushed ahead with the extraordinary legislation for one reason - to woo voters ahead of the legislative elections in April. But it failed to consider the immense fallout and side effects. To reimburse amounts above 50 million won as well as subordinated debt, public funds in excess of 100 billion won would be needed. The assembly plans to draw the money from a special account in the state-run Korea Deposit Insurance Corp. But the money there has not been set aside for savings banks’ customers. They are savings taken from deposits in banks and insurance companies. They also function as guarantees on bank deposits and insurance. If the account runs out of money, the government must inject more public funds taken from taxpayers’ pockets. In short, ordinary taxpayers - including the banks’ customers - will have to foot the bill of rescuing victims. The biggest danger here is the risk of moral hazard, as the government will be pressured to rescue consumers whenever a financial company goes bust. As such, the committee should retract the bill.