Here’s my article from yesterday’s Fin
Bank on change, but not here
A year ago, looking at the economic outlook for 2008, I observed that ‘the financialisation of the economy has exceeded the capacity of financial markets to manage risk’, and predicted that ‘large classes of financial assets, and the associated financial markets, may simply disappear’ (Flip side of the flop, AFR 14/2/08). This seemed a bold prediction at a time when only a handful of forecasters, like Nouriel Roubini of New York University, predicted a serious recession.
Even the most bearish of analysts would scarcely have dared to suggest that, by early 2009, the hottest issue of economic debate would be the desirability of nationalising the world’s biggest banks. Yet the debate over bank nationalisation has been subject of front-page headlines in the New York Times for weeks now. The dominant view is that, explicit or surreptitious nationalisation is inevitable.
The US government is already the biggest shareholder in Citigroup and Bank of America. And despite two rounds of rescues, it seems clear that much more public money is going to be needed. While Henry Paulson held the reins at the US Treasury, funds were ladled out with no strings attached and little expectation of any return. Now, politicians and the public are asking why they should not see some reward for the risk they have been forced to take.
Equally importantly, policymakers are starting to realise that much more than a short-term bailout is needed here. What is needed to resolve the crisis is not only to fix the problems of individual banks, problems on a much bigger scale than have been seen before, but to reconstruct a failed global financial system.
Financial restructuring is going to be a huge challenge, involving both a radical redesign of national regulations and the construction of an almost completely new global financial architecture. To attempt this task while leaving major banks under the control of discredited managers nominally responsible to shareholders whose equity has already been wiped out by bad debts, is a recipe for disaster.
The problems are illustrated by the fate of proposals to create a ‘bad bank’ which would manage the disposal of the toxic assets accumulated during the bubble. The problem is that, if such assets were acquired at market prices, large numbers of banks would be revealed as insolvent. On the other hand, if governments bought the assets at the banks’ book prices, the effect would be to reward the speculative excesses of the bubble era and set the stage for an even greater disaster in the future. Only by taking over the entire bank can this problem be addressed.
The speed with which bank nationalisation has risen to the top of the policy agenda has found the international economics profession largely unprepared. The wave of privatisation in the 1980s and 1990s, supported by economic analysis that ranged from simplistic to plain wrong, seemed to many to settle the issue once and for all. As a result, there was very little interest in analysis of the conditions under which public ownership of businesses enterprises might be socially beneficial.
As Joshua Gans of Melbourne Business School has pointed out, Australia in the 1990s was one of the few places where economists paid serious attention to these issues. The analysis that emerged from these debates supported a mixed economy, in which public ownership may be appropriate for capital-intensive enterprises requiring close regulation, but not for small and medium businesses, or for firms operating in competitive markets where light-handed regulation was appropriate.
A central factor in the Australian debate was the risk premium for equity, that is the difference between the rate of interest at which the government can borrow and the rate of return expected by investors in equity and demanded by buyers of risky corporate debt. With the blowout in spreads that has emerged as part of the financial crisis, the Australian analysis of public ownership and nationalisation is more relevant than ever.
Paradoxically, however, Australia is one of the few countries where nationalisation is not on the policy agenda. Our banks remain profitable and their balance sheets appear strong.
The introduction of unlimited deposit guarantees last year, and the recent announcement of a partnership between the Rudd government and the major banks to maintain finance for the commercial property sector have substantially increased the role of government in the banking sector. Nevertheless, it seems likely that, by the end of 2009, Australia will be one of a handful of countries where all major banks are privately owned.