Wednesday, 25 February 2009

Bank Nationalisation

The US is struggling to come to grips with the unpleasant choice of having to nationalise some of its banks. Citicorp looks set to become the first major bank in the US to become part nationalised, with the government likely to take up a 40% stake. Frannie Mae and Freddie Mac, while not being banks, are in effect nationalised, as is AIG. In the UK, Northern Rock was the first to be taken over and HBOS and RBS are already majority owned, with every likelihood of becoming fully government owned.

Nationalisation is a dirty word in the more capitalist of economies. Through bitter experience, these countries have realised that government ownership of business does not work. Especially in the US, it would be political suicide to nationalise. And yet what can governments do in the crisis situation that we face today. It has doled out a large sum of money to Bank of America and Citibank just recently and now the market value of both these banks is lower than the amount the government gave each of them. How long can it keep shovelling money in ? Even Alan Greenspan , the doyen of laissez faire capitalism, now favours "temporary nationalisation" .

The prevailing view amongst most free market experts is that governments will have to nationalise the banks, restructure them by creating a "bad bank" to isolate the worthless assets, get credit moving again and then quickly get out once greater normalcy comes to markets. Nobody wants government involvement once the good times come again.

I am a die hard free markets man. To me, nationalisation, is a painful word. And yet, I think that the above prescription from the free market votaries is a bit rich, especially the "get out when the good times come" part.

Governments are, and will be, involved in the financial services industry for two reasons. One is that unlike any other industry, this industry carries a systemic risk which can bring down the whole economy, like what we are witnessing today. The second is that implicitly, there is a sovereign guarantee on bank deposits - no government can watch a run on a major bank and do nothing. If the government is therefore a guarantor of last resort, it is completely hypocritical for the industry to then argue that governments leave them alone, except when there is a crisis.

My humble two penny contribution to the debate. Governments have no option but to take part, or complete, ownership of the troubled banks. It is distasteful, but there does not appear to be any other alternative. Even the US Republicans are slowly coming around to this view. Post restructuring, at the right time in the future, governments divest their shareholding, making a profit for the tax payer. Its absolutely imperative that the existing shareholders of the banks lose their shirts, not the government. But even after divestment, governments retain a golden share, which will rest with an independent regulator, and not with the politicians. This golden share will ensure that extremely stringent regulations are brought to ensure that the probability of recent events recurring again are very remote.

Regulations have to make financials services a boring business. Capital adequacy ratios have to be massively increased and set in stone - unchangeable whatever be the circumstances. The nature of activities each type of financial institution can undertake, has to be severely limited. Anti trust measures should ensure that no institution becomes so big that "it cannot be allowed to fail". Very severe restrictions need to be placed on the types of instruments that can be created and traded - no more instruments of mass destruction. Perhaps an additional profit tax to create a fund for the day when another disaster will surely come - the history of the world is littered with painful bubbles. Innovation will, alas, be severely curtailed. Profitability of these institutions will become limited. Liquidity might become restricted as speculation, which provides the liquidity, will diminish if the opportunities for making extraordinary money are not there. Maybe every economic opportunity may not get the funding it deserves. But so be it.

Government should not run businesses, for sure. But they must be the schoolmaster, with cane in hand and corporal punishment freely allowed.

Financial services should become an utility industry. Dull and boring maybe. The best brains may not want to work there. Perhaps that might be to the good. We'll know we are safe when the banker is mentioned in the same breath as a train spotter.


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