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Taboo of nationalisation

Is it a good time to nationalise the banks?

The taboo of nationalising a bank – evident in the government’s reluctance to accept that option for Northern Rock – may have to be overcome in the next few years.

This is one lesson to draw from previous banking crises. The Swedish banking crisis for example, is generally regarded as well handled. And the solution there was to take ownership of the failing banks, to strip out the bad assets and to put them into separate well-funded asset management companies whose only job was to extract as much value from them as possible.

Once that had been done, new “cleaned up” banks could be re-established and operate again very quickly. It worked for them, although it was helped by buoyant economic conditions.

But it tells us that a successful resolution of a bank crisis can involve governments or central banks owning more of their banking systems than they would probably like.

The relevance of this argument today is that the banking crisis we are now in is one in which the banks’ own capital has been eroded by losses they have incurred on their past decisions.

The banks' capital is best viewed as a relatively small rock, on which the rest of their activities sit. Before they can borrow and lend £12, they need £1 of their own capital to serve as a kind of safety cushion. That capital is one thing that makes it safer to lend your money to a bank, than it is for you to lend directly to the bank’s borrowers.

It is no wonder that bank capital is regulated. When borrowing and lending is profitable, it is tempting for banks to scale up their operations and to borrow and lend too much in relation to their capital, in effect reducing the effectiveness of the potential capital cushion.

The problem for all of us is that when bank capital is eroded, the banks’ lending has to be curtailed, with broad economic consequences. Whatever the central bank rate of interest, or whatever the credit-worthiness of potential borrowers, banks are constrained from lending and sometimes have to call in loans that have already been made.

We want banks to lend responsibly, but we don’t want them to curtail lending too far.

So the goal has to somehow be to get more capital into the banks.

That’s not about us putting deposits into banks, or central banks lending money to banks… it is about extra money finding its way into the banks, to rebuild the capital rock on which successful banking depends.

Who can invest new money in banking right now?

The most obvious candidates around the world are the sovereign wealth funds sitting on large amounts of spare cash.

But in the absence of clear information about how much the banks are worth, the funds may be reluctant to throw more money in.

(The experience of CITIC Securities may put other investors off. As China’s biggest brokerage firm, it promised last October to invest $1bn in Bear Stearns in return for 6% of the company, a price that looks high given the news that has occurred since.)

If wealthy foreigners are not going to inject capital into the banks, and if the crisis is as bad as some suggest, the best candidate to inject capital might instead be our own governments.

It’s not quite bailing the banks out, and it would not be aimed at rescuing the shareholders – the new money would go in, and in return the state would obviously have to take a stake in the banks future profits. The existing shareholders would lose some of their share.

These kinds of solutions are not infrequently adopted, but normally occur when the banks have run out of money. But does it have to be a 100% stake in a bank? And does it have to wait until the bank is in dire trouble?

Ultimately the solution to the problems of the banks is clear: the full scale of losses incurred in the bad lending of recent years has to be recognised; the failing assets written off without a fire sale of assets; and for the banks to be recapitalised and re-launched from a healthy base.

Taxpayers might object to their money being sent in to support banks, but it is probably money well spent if it supports the economy generally, and stops the rot quickly.

In fact, there is one final lesson to be drawn from history, from the Japanese banking crisis, which was less well-handled than Sweden’s.

As problems unfurled in the early 90s, the public objected to the idea of helping banks and only one trillion yen of support was mobilised. By the end of the decade, as the crisis worsened, more like 6o trillion had to be found.

These things can get very out of hand.

Comments   Post your comment

  • 1.
  • At 04:24 PM on 17 Mar 2008,
  • tonyw wrote:

"the full scale of losses incurred ....to be recognised" Now how exactly are these to be quantified? one minute some assets are worth billions the next almost nothing.

Just like nearly every bank crisis it is caused by lending to speculate. Joe Public might have a bit more sympathy if it were not for the elite creaming off huge salaries and bonuses.

  • 2.
  • At 04:35 PM on 17 Mar 2008,
  • ~n wrote:

Free speech requires legal and moral limits because it can be abused.
Why then do we feel that a free market is different and doesn't need regulation? Totally free markets are flawed; it was easy to see (many predicted problems in advance, not just myself) and now we've arrived.
Markets based on greed will clearly fail (anyone want to argue with me?) and we can't carry on doing it like this.

  • 3.
  • At 05:02 PM on 17 Mar 2008,
  • jim wrote:

Evan, I've heard that the FED have another $400 billion (?) available to carry on funding their banks on top of the $200 billion credit they extended last week with the Term Securities Lending Facility.

The outstanding debts held by the banks are over $20 trillion. That's 50 times the amount they have left in the kitty. On those numbers a 2.5% fall in the value of assets would wipe out the FED. The fall will be a hell of a lot more than 2.5% I think.

It appears that the FED (US tax payer) could easily go bust themselves if they take the step you are advocating here.

They would be better off allowing those banks to simply fail in this scenario.

  • 4.
  • At 05:30 PM on 17 Mar 2008,
  • Scamp wrote:

Personally I'd nationalise all our banks now simply as punishment for the appalling way in which they've behaved for the past twenty years. They had their chance following deregulation to become a genuine force for good for the UK economy but failed miserably.

  • 5.
  • At 05:47 PM on 17 Mar 2008,
  • Ted Grant's Ghost wrote:

Nationalise the banks!

And all the rest of the top monopolies!

Capitalism is in crisis again!

  • 6.
  • At 06:23 PM on 17 Mar 2008,
  • sam asseer wrote:

Financial markets are operating out of greed. The governments, at least in the past few years, have demonstrated, that for them power comes first.

Now it must take a real wisdom, to convince the public,that on top of military and political power we will give the control of our pocket and savings to those who in general we do not know if they were the best choice in the first place to govern. And what is left is the spiritual power, why not the church. And then in the real social sence, we put a chip in each person, so he cannot say the king is naked.

Question, who is a leader today that has absolute wisdom and respect for this added task. Our option will be to make one in the lab.

No thank you.

  • 7.
  • At 06:47 PM on 17 Mar 2008,
  • Jim Currie wrote:

All very well¬! Tax payers might well be advised to allow governments to use tax income to support failing banks but face it! banks are like every other business - except that they can do damage out of all proportion to their individual importance. Sickness is just that and needs; not a means of feeling better but an 'anti-virus'injection or some kind 'serum' to prevent the 'sickness' occurring again. So far it looks like lots of good being thrown at lots of bad in the hope that somehow one will overcome the other. I don't think so!

  • 8.
  • At 10:26 PM on 17 Mar 2008,
  • Jimmy wrote:

Evan, I've heard that the FED have another $400 billion (?) of Treasuries available to carry on funding their banks on top of the $200 billion credit they extended last week with the Term Securities Lending Facility.
The outstanding debts held by the banks are over $20 trillion. That's 50 times the amount they have left in the kitty. On those numbers a 2% fall in the value of assets would wipe out the FED. The fall will be a hell of a lot more than 2% I think.
It appears that the FED (US tax payer) could easily go bust themselves if they take the step you are advocating here.
They would be better off allowing those banks to simply fail in this scenario and shore up what is left standing after the rout.

  • 9.
  • At 10:36 PM on 17 Mar 2008,
  • Ian Kemmish wrote:

I'd disagree with "~n" that the markets have failed (to say nothing of his other proposition!)

Markets oscillate. They have done ever since the "seven fat years and seven lean years" that kept cropping up during the budget debate. Cycles of overconfidence and overcaution are a possibly inevitable part of human nature (check out an old Horizon programme about the history of bridge building), but I think that even if the politicians did finally manage to smooth out economic cycles, our problems would only just be beginning.

Downturns perform the valuable service of natural selection. Not only do they obviously punish the imprudent, but they also provide opportunities for contrarians (and wasn't Joseph just telling Pharaoh to be contrarian?) When large companies are trying to cut costs back to the bone, small innovative suppliers have a golden opportunity to win major contracts, which will bear fruit in the next upturn.

Without market oscillations, you wouldn't have that natural selection. What would that look like? The UK automotive industry in the 1970's, perhaps. Or the Soviet economy when Mikhail Gorbachev took charge in the 1980's....

  • 10.
  • At 11:55 PM on 17 Mar 2008,
  • Joe wrote:

They profit by their commercial decisions, let them lose by their commercial decisions.
Why artificially support any commercial venture that can not stand on its' own two feet.
If the banks are on their knees, it is because they bowed to excessive greed chasing higher returns with less and less capital.
They have played fast and loose with their money, don't let them get away with their mistakes by allowing them to play fast and loose with our money.

  • 11.
  • At 10:09 AM on 18 Mar 2008,
  • Nailed wrote:

It would be a source of some satisfaction if individual bankers and financiers were to take some personal pain for their recklessness and imprudence in making these toxic loans in the first place. Which of them thought it a good idea? Why were customary banking ideals of prudence and caution abandoned?

How come they can walk away unscathed from having plunged the world economy inot crisis, and ruining the futures of those about to take their pensions?

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