Tuesday, 27 January 2009

Bank expropriation is rational, but neither socialist nor sufficient

by Paulo L dos Santos

The chronic banking crisis is flaring up again. Banks in the US and Britain continue to hemorrhage capital as recession and falling asset prices add to their losses. CDS spreads on bank debt are back on the rise. And the only thing propping up bank shares are daily promises of innovative ways to inject billions of fresh public money into the sclerotic veins of privately-run banks.

The latest such cures being prescribed involve either state-backed insurance of bank assets or the establishment of a state-backed ‘bad bank’ that would buy and hold toxic assets. The argument behind them, made most clearly by Paul Myners of the British Treasury, is that if the public takes on the bulk of the asset risks and losses lurking in bank portfolios, banking will become profitable once again, helping their private recapitalisation, and an eventual resumption of normal lending levels.

Why should the public lose its shirt to restore profitability to a sector that has pocketed billions as it created a crisis that will likely cost tens of trillions of dollars? Because, Mr Myners states without the distraction of substantiation, ‘The capacity for soundly managed banks and markets to support the generation of wealth in the economy could never be matched by the public sector’. The same argument has been made recently by The Economist and Alan Greenspan, also on the basis of pure chutzpah.

Yet the evidence supports a much dimmer view on the ‘entrepreneurial’ capacities for ‘wealth creation’ of private banks. Leading private equity boss Guy Hands recently commented to the Financial Times that, to his mind, British banks have lost all capacity to make loans to corporations in the domestic real economy. In my recent study of the activities of top international banks, I have documented what has been keeping them busy and profitable. The picture that emerges is one of remarkably well remunerated parasitism.

Even when they actively made loans, Citigroup, Bank of America, HSBC, Barclays and RBS centered their lending on mortgages, credit card and other loans to individuals, and loans supporting financial engineering. Lending to individuals has transferred increasing shares of wage income into bank profits, and its high profitability was a central contributor to the current financial crisis. Financial engineering operations aim to capture capital gains that are significantly funded from the mass of retail investors through fees and systematically lower returns on their pension, education and other savings. Lastly, banks have drawn astronomical revenues from card fees and other account service charges paid by clients to access and use their own money and accounts: a total of US$ 50 billion for Bank of America, Citibank, HSBC and Barclays in 2006.

In addition to being remarkably poor value for public money, plans to insure bank assets or create a public ‘bad bank’ are almost guaranteed not to work. They assume it is possible to identify and fence off ‘bad assets’ and quantify associated losses. This is impossible at this early stage of what will likely be a protracted recession. Any such programme would be followed by a steady stream of new losses, triggering new panics, renewed instability, and new cuts in lending. Ask the Japanese.

That takes me to the question of nationalisation, which, for all the recent hand wringing in the financial press, is a monumental non-issue. Bank losses will continue to mount and private appetite for investment in banks is unlikely to improve for many years. Gone are the good old days when Western states could count on their wealthy political clients in the Persian Gulf to pitch in the odd billion to support their private banks. In this setting, states will have little choice but eventually to nationalise weaker banks. That, in turn will likely send remaining private investors in other banks running for the exits, as recently argued in the New York Times.

The question is how banks will be nationalised and run. The Economist demands that any necessary nationalisations be undertaken ‘at market prices’, without seriously considering what those would be had states not supported banks. And both British and US governments have noted their commitment to run their investments on arms-length bases, leaving control to the officers and major shareholders that created the current financial mess.

There is a simple, rational alternative that needs urgent public discussion. Expropriate the banks—or, for those partial to more diplomatic language, nationalise them at the market prices that would prevail had the public not poured hundreds of billions into them. Then run the banks under the sole imperative of stabilising the financial system and paving the way for economic recovery, with no constraints imposed by the need to attract private capital or maintain future private franchise value.

Expropriation would lower the fiscal impact of state intervention. It would also curb the massive hoarding currently taking place as banks try to build up capitalisation levels. State banks could maintain lower capital reserves—after all, the only thing maintaining public confidence in the solvency of banks are state guarantees. This would allow additional room for credit creation, and render recent interest rate cuts effective.

State banks would also be able to provide relief on the debts currently saddling many households, helping provide a welcome boost to aggregate demand. Lastly, state banks could curb the more egregious practices of private banks: exorbitant account, overdraft and transaction fees; interest rates on credit to households; gains made on trading and own accounts at the expense of retail savers; and, of course, bonuses.

These measures are unlikely to be taken by currently dominant political forces, even though such policies are neither socialist nor in themselves steps towards socialism. They are just rational attempts to stop the current economic bloodletting. Economic recovery will require taking on the long-term systemic economic imbalances that conditioned the current meltdown. Those include falling real investment by non-financial corporations, mediocre productivity growth, growing private provision of pensions, health and education, and rising inequality.
Addressing those issues will require significant socialist inroads into the functioning of the economy and dramatic political changes. They also require an integrated, long-term understanding of the current crisis and secular developments in the real economy. Stay tuned.


  1. This comment has been removed by the author.

  2. My question is, how would banks whether expropriated or not now be able to reassess assets at value before money was poured into them?

    I love the blog by the way.

  3. Ah sorry I meant to ask how will you judge the market price of banks that already have so much public money poured into them?

  4. First on the second question. There should be little doubt that without the various infusions of public money many of the world's leading banks would have a market capitalisation of right around zero. That would be the fair 'price' to pay. Anything more than that would be, well, yet another rip off of the public. That leaves the complicated question of what to do with bondholders, which requires detailed attention, including the possibility of differential treatment across holder types.
    On the asset side things are also tricky. The banking sector will continue to take losses, especially as the recession deepens. Proposals for asset insurance or asset purchases by the state pass the costs of these losses to the public while leaving the good assets in private hands. That is also a bad deal for the public.
    Nationalisation would give the public both good, bad (and ugly) assets. That is at least a little bit fairer. In addition, state banks could help unwind bad assets in an orderly (and socially responsible) fashion. This could include different forms of debt write offs, voluntary schemes for state banks (and housing agencies) to take ownership of houses and renting them to former mortgage holders, etc.
    All of this, of course, is well beyond that which is politically acceptable right now. That does not make it any less necessary.