Nationalisation is on the agenda across the globe – is it a step too far or do governments have no choice, asks Proinsias O'Mahony
“SHOOT THE bankers, nationalise the banks”, reads one headline. “Time to quit mucking around and make with the nationalisations”, reads another. No, not headlines from some obscure hard-left publication – the respective pieces were penned in the Financial Times and the Economist, no less.
Bank nationalisation is much on the agenda across the globe, with an increasing army of supporters saying governments have now no choice but to bite the bullet and seize control of failing institutions. Should they? Or is nationalisation a step too far?
For
The Swedish example: the blueprint for successful handling of a financial crisis is provided by Sweden’s centre-right government in the early 1990s. It forced banks to write down their bad loans and then injected equity, nationalising the country’s two biggest banks.
The banks were detoxified and later re-privatised, with taxpayers getting back much of the money they had contributed.
Bailouts and partial nationalisations don’t work, according to influential economics professor and FT blogger William Buiter. Partial state ownership and the threat of future state control incentivises banks to stop lending.
Banks look to pay back government money “as soon as possible” to “get the government out of its hair”, causing them to “hoard liquidity”.
This helps them avoid outright nationalisation but cripples the economy. German economics professor Hans-Werner Sinn agrees, saying that government proposals to cap corporate salaries mean most banks would prefer to cut back on business lending and stumble along, zombie-like, rather than accept government interference. AIB CEO Eugene Sheehy, who said in October that “we’d rather die than raise equity”, comes to mind.
The alternative to the “unfortunate halfway house” prevailing at the moment, Buiter says, is temporary nationalisation.
There’s no point trying to nurse banks back to health – it’s a case of “dead men walking”. Nouriel Roubini estimates that US financials will ultimately suffer credit losses of $3.6 trillion. The US banking system, with capital of $1.4 trillion, is “effectively insolvent”. Roubini’s estimate is high, although losses in excess of $2 trillion are commonplace today. In Britain, RBS analysts Ian Smillie and Cormac Leech describe British banks as “technically insolvent” on the basis that they are suffering from a £36 billion shortfall and are facing an additional £143 billion in writedowns.
Author and professor Frank Partnoy says that banks have been insolvent for more than a year, surviving on a diet of misplaced government support and investor denial. Current policies are “the financial equivalent of putting tubes into dying patients”.
Opting for more sweetheart deals means throwing good money after bad. In November, the US government injected an amount into Citigroup than exceeded its entire market capitalisation. It also guaranteed the firm’s toxic assets to the tune of $306 billion. Despite that, it ended up with a mere 7.8 per cent equity stake while management was left in place.
Recently, Bank of America received $20 billion of government money on top of the $25 billion it received months earlier. It was also given guarantees of $118 billion on potential losses.
It’s not just a waste of money, it’s a case of “moral hazard” – heads you win, tails I lose. Taxpayers are taking all of the risk but none of the reward. Hedge fund manager Whitney Tilson says that current US plans will lead to “the greatest heist in history”. Poor decision making is rewarded if shareholders and debt holders are not wiped out.
Markets are saying that nationalisation is inevitable anyway, as this week’s collapse in Irish and British bank share prices show. Banks cannot receive the monies they need from the private sector, as AIB and Bank of Ireland are finding out. Governments have been behind the curve throughout the crisis – they must grasp the nettle and listen to what the markets are telling them.
“Creeping nationalisation”, as it’s been called, has already set in. Better be done with it sooner rather than later.
Ideological hang-ups mean too many see nationalisation as a last resort. In truth, the financial sector has been kept on life support though massive government intervention for over a year now. Recognising that fact through nationalisation and preparing the sector for eventual re-privatisation is a victory for pragmatism, not ideology.
Against
The Swedish example is simplistic. It nationalised just two banks whereas more than 300 US institutions received TARP money, many of them healthy and solvent. Nationalising en masse is wrong. Also, the Swedish example was local in nature whereas today’s problem is global. Were Britain to nationalise RBS (or others) and follow the Swedish example of writing down assets to nuclear levels, the knock-on effect on other global financial players would be catastrophic.
Governments are not the best people to run banks. A couple of years of crisis in the financial sector does not negate the long-held idea that the private sector manages resources more efficiently. Former RBS chief executive Sir George Matheson said the government should instead guarantee the bank’s deposits and “let it trade out of difficulties”.
Fear of nationalisation has driven financial shares below their true value. For example, AIB is currently valued at around €500 million, even though its has stakes in US bank MT and Poland’s Bank Zachodni WBK valued at €800 million and €1.1 billion respectively. Falling share prices are being used to justify nationalisation, even though the fear of nationalisation has caused the falling share prices. Shareholders have the right to hold on for eventual recovery.
Recent UK measures should help enormously. Besides the £250 billion credit guarantee scheme, regulatory changes mean that banks are being given additional latitude in terms of their capital ratios, with regulators accepting core equity of 4 per cent and Tier 1 capital of 6-7 per cent.
The RBS analysts who said banks were “technically insolvent” added that this is not unusual “at this stage in the economic cycle”, which is why the regulators have given banks breathing space. As Goodbody’s Eamonn Hughes said, similar regulatory moves in Ireland would make nationalisation fears “overstated”.
The cost would be enormous. Despite share price falls, buying up the banks would not be cheap (JP Morgan alone is worth almost $85 billion).
Also, the risk of individual states defaulting on their debt is hugely increased by increasing their exposure to the banking system via nationalisation.
The odds of a British debt default hit record levels after it took a 70 per cent stake in RBS. The UK is at risk of losing its AAA credit rating and markets estimate that it stands a one-in-10 chance of debt default in the next five years – something that hasn’t happened since the Middle Ages.
The cost of insuring Ireland’s debt against default also hit record highs in the wake of the Anglo nationalisation, soaring by over 100 basis points to 297bps in little over a week. That’s over twice the cost of insuring Tesco’s debt and more than five times that of Germany’s.
What’s wrong with the “creeping” nationalisation approach? “The good thing about creeping, as opposed to sprinting, is that it’s easier to stop and reverse course if obstacles are in the way,” as Financial Times city editor Andrew Hill put it.
The notion that nationalised banks could be quickly returned to private ownership is facile. Such a process would inevitably be drawn out, during which time all the disadvantages of public ownership would become obvious.
George Matheson said nationalisation would bring “pressure” to do things “according to government practice rather than commercial banking practice”.
In particular, politicised lending. “The focus isn’t going to be on the needs of banks,” said Obama economic adviser Larry Summers. “It’s going to be on the needs of the economy for credit,” a point also hammered home by Gordon Brown.
The last thing massively indebted societies need, however, is a return to the easy credit that triggered this crisis.
Government demands to increase mortgage lending, even though property values remain at historically elevated levels, are as misguided.
