A bit more on bank nationalisation

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.

35 thoughts on “A bit more on bank nationalisation

  1. I strongly agree with Ernestine 22. I am not an academic but Xanthippe is and if her experience is anything to go by I can fully understand why academics prefer research. Teaching in universities has been turned into an overworked often underpaid profession, with students churned through like a sausage machine. Meanwhile there is a mindless stream of time consuming admin tasks that are imposed from above by careerist bureaucrats that make the public service look like a model of efficiency. Here at Adelaide the admin staff actually outnumber the lecturers, yet if there are budget shortfalls the cuts always fall on those who generate the income (!) = the lecturers.

    The workloads are such that you can only keep up research if you buy yourself out of teaching with grant money anyway. The ratio of teaching staff to students in some faculties is worse than in most private high schools.

    Sorry for the rant, but those who criticise academics doing research don’t know the reality.

  2. Nanks at 20

    I have stats on the decline of teaching only positions employed as fractionals or full time since 1990. In 1990 if I recall these were about 60% declining to 10% by 2004 ie teaching only positions are accounted for 90% by casual academics. There is some decline in teaching and research positions for the securely employed and the percentage of reserach only positions is overwhelmingly securely employed.
    Unfortunately I dont have the stats with me but over the same period student staff ratios have increased across the board in public unis ie bigger noisier classrooms staffed mainly by casuals. Its pretty ugly really because there are real disincentives to entry for would be academics. Pay for casuals two semesters a year isnt enough to pay rent and fund your own postgrad studies until you are deemed acceptable – in many unis this means through the first review of a phd before you can get secure employment (and what is secure when its likely to be on contract for a few years anyway) on a salary at fractional level A associate lecturer at 65K (may be slightly more now but not much). Its rather sad.

  3. Well bank stocks have gone up here in the US on talk of creating a “bad bank” to house these toxic assets….in return for govt equity.

  4. The Dawkins green paper in 1987(?) had the impress of the economic rationalist, without thinking through the secondary consequences. The idea of deferring the HECS fee and repaying via the taxation system, well that was inspired. Deferral to a future date meant only the really poor were deterred in any numbers. Another push was to reduce the university sector’s dependence upon government funding. A strong desire to make research have a more commercial bent was also a factor in the Dawkins revolution.

    The secondary consequences are manifold, but here are a few.

    People start paying back HECS around the time they are purchasing a house, getting married, having kids: it adds to the financial pressures.

    Casual employment of teaching-only staff soared; some cash-strapped departments removed full-time tutor positions and replaced them with hour by hour casual only. The old deal, of working on a PhD halftime while doing a tutor job, was thrown out, leaving the PhD candidate with no financial support during the university breaks.

    Pharmaceutical companies and many others used university research to their own advantage. Commercial-in-confidence agreements lock down research shared with the companies. Rather than look for a paper the question is “How many patents?”

    Departments that could not match the salaries available in free enterprise lost young staff with good potential.

    Meanwhile, departments that either had nothing of interest to free enterprise, or that had research whose nature involved long lead times, languished if they didn’t shrink away to insignificance.

    A shift to overseas students as a large scale revenue stream increased the pressure on departments to use casual positions for lecturers instead of full-time or permanent positions. This made it much easier to match annual demand and staffing levels. At a price.

    It was not all bad but I still wonder if it was really worth it.

  5. Donald#29
    Over the past ten years I have watched bright young things leave for better paying (more secure) employment elsewhere than academia because they cant fund the long breaks between casual teaching stints. It has gotten worse – some unis shrank their semesters from 14 to 12 to 8 weeks (twice a year) so while the bright young things stick it out a few semesters and chuck in the towel – lecturing contracts go to the “should be retired” and that can get to be a nice cosy regular reirement income on top of the generous super from earlier days and of course it repeats semester after semester…..but what about when the older finally age….who is coming in apart from foreigners phd trained overseas who are less likely to stay?

    Its a considerable barrier to entry for young entrants into the profession and in my more cynical moments I could even consider, under the unenlightened “anti investment in tertiary education” policies and antipathy of the prior coalition government towards the “elites” that inhabited universities, whether it wasnt designed that way deliberately?

  6. We need banks who work for the benefit of the nations and not for making profit. Consequently, all banks must be sponsored by the government.

  7. How about cooperativising the banks instead? Issue all deposit holders shares to the equivalent value of their deposits. They’re the ones with the most incentive to ensure that the institutions are well and conservatively run.

  8. While Henry Paulson held the reins at the US Treasury, funds were ladled out with no strings attached and little expectation of any return.

    As Krugman points out, when banks raise capital they normally give shares to the people who supply the capital and there should be no difference if that capital comes from taxpayers. It’s pretty simple really, if someone puts up capital they should be entitled to shares regardless of who they are or what special name is used with share acquisition by that shareholder.

    Of course, banks in Australia are not asking the government for capital (yet).

  9. James Haughton “How about cooperativising the banks instead? Issue all deposit holders shares to the equivalent value of their deposits.”

    James – understand where you’re coming from but the banks need new capital. I.e. unless the depositors are going to hand over their deposits to the banks (and not get it back) this is just giving away shares in the bank for free.

    It seems a lot of people don’t understand the situations with bank solvency.
    At the moment in many countries (US
    UK, Iceland etc) the banks assets are worth less than their liabilities and they don’t have enough reserve capital to make up the difference. Because the numbers are so large and people are so fearful that these assets values will continue to decrease governments (or multinational bodies like the IMF) are the only ones who are large enough to put in enough capital to save these banks from growing broke.

    In other countries (especially the Baltic States) the main banks are subsidiaries of large foreign banks. The added fear there is that as these large banks come under pressure to support their home market they will pull the plug on these subsidiaries and cause the collapse of these economies where the government is not financially strong enough to fill the gap.

    The alternative to the government putting in capital to the banks is to force those who have lent to the banks (other large institutions, deposit holders etc) to convert their loans into capital. This is generally what happens during a bankruptcy proceeding. The alternative in bankruptcy is selling off the assets of the bank and they generally aren’t worth a huge amount as it’s the ongoing trust in the bank which is most valuable and this has been lost. Governments have generally guaranteed deposits to take the fear of those lending to banks loosing out (and therefore greatly reducing the possibility of a bank run – which will send the bank broke).

    Basically what governments and reserve banks are doing now is avoiding the mistakes that exacerbated the great depression. No doubt they are making different mistakes. I agree with John Quiggan is that one huge mistake is failing to penalise/replace the top management of the banks who stuffed up. But really the main msitakes have been made in the boom.

    So far Australian banks have stood up OK but there have been losses and there will be more to come. To this stage the banks have been able to raise private capital through the stock market to offset those losses as the losses aren’t too big. As a number of people have pointed out here if property values collapse – commercial or residential then banks losses will be greater and if more people loose their jobs consumer bad debt will rise and this will also hurt banks.

    I would charactertise the Australian government’s efforts to this point as being good in the short term but doing a fair bit of damage in the longer term.
    E.g.1. Stimulus stops us falling as deeply into recession as other counties but means a need to savagely cut government spending or raise taxes in the future.
    E.g.2. Incentives for first home buyers helps reduce falls in prices and falls in building activity but means we face the pain of more falls in prices and building activity later.
    E.g.3. Supporting the banks now – decreases disruption in the financial system now but increases likelihood for risky banking practices continuing later.

    This short term focus makes sense if the global downturn is going to be relatively short and we can deal with the pain in a time of solid economic growth. However if it’s going to be long (i.e. a global L shaped recession) Australia does face some considerable risks due to the huge level of consumer debt and low private savings rate (and the associated high level of foreign debt and current account deficit). This mean we as a whole country are in real trouble if we become viewed as a risky country to lend to. If we continue with this “spend and borrow ourselves out of trouble mentality” in a global environment where growth is low for years to come and where our commodity price exports will continue to decrease in value then lending to us may dry up. Then we are back to Paul Keating’s “banana republic” comment and sharp cut backs in government spending and reduced credit flows to households (and therefore decreased private spending) and back in another recession in say 4-5 years time but in a much worse situation as fiscal and monetary policy won’t be in a state to do anything productive about it.

    So ease up Kev07, recklessly spending, borrowing and lending without worrying about the risk in the medium term got the world into this mess let’s not mistake the same mistake again.

    Sorry I got off the bank nationalisation topic there – was on roll.

    Steve van Emmerik

  10. I find the large number of firms now going to the markets to raise equity somewhat disturbing. For existing shareholders this spells further dilution and loss of value on top of the GFC price falls. The whole mess really looks to me like there have been too many firms in the financial sector chasing too few shares on a global scale, and as it all corrects companies who may not now be able to get finance or liquidate assets to correct their shaky balance sheets and debt / equity or debt /asset ratios are now calling on shareholders to take up the mantle. Shareholders dont really have any choice if they want to retain their interest in the firm, but many may be induced to sell further exacerbating the downside. I really wonder if the enforced super streams on a global basis didnt contribute to the overvalued shareprices, result in massively inefficient gains for the few and now losses for many. Something has to be done about financial sector management and regulation (perhaps looking at regulation or lack of that may have contributed to this unsustainable boom).
    Obama is taking some initiatives on executive remunerations. What are we doing here?

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