Between the lines: Banking on the state would be a bad idea

Published on Thursday 19 February 2009 20:30

SUGGESTIONS are now arising, I note most recently in the Investors' Chronicle, that buying HBOS has turned out to be such a bum deal for Lloyds that it might want to unstitch the whole thing. It seems improbable, but if it were to happen, there is only one possible alternative owner for the crock that was HBOS – the government.

Amid the much more plausible suggestions that Lloyds and RBS might have to go back to the government for yet more capital, a big question arises: should the banks just be fully nationalised?

Since financially astute organisations such as the Financial Times and the Economist which are normally as far removed from Marxist zealotry as it is possible to get, have suggested such a move, the idea looks to have something going for it. Why?

The general argument is that by, in effect, taking the banks off the stock market, a lot of instability caused by share prices spiking up and down on this or that rumour would be removed. As recent history has taught us that people use share prices as a barometer of a bank's health, this would also reduce the chances of Northern Rock-style runs of people clamouring to get their money out.

The pro-nationalisers argue that much more instability has yet to come because they believe that the banks are actually dead companies being kept alive by artificial life support systems – the government giving them financial transfusions. But so clogged and sclerotic are the patients' arteries, more and more blood clots of duff loans and poisonous "assets" will keep on turning up. Far better, they say, to just take them over now and then we can find out just how bad the toxins are and just where all the blood clots are lurking.

The example most often cited in support of this case is Sweden where, after a property price bubble burst, there was a significant banking crisis in 1992. Two banks were nationalised and all the bad-looking debts from them and some other banks in less trouble were dumped into two government-owned vehicles, which, in the current jargon, are known as bad banks. Eventually, all the dodgy assets were sold back to the good banks. On some calculations, the taxpayer wound up with a profit though others say there was a loss.

The 1989 crisis in the American savings and loan companies (the equivalent of our building societies) was dealt with in the same way and, again, there is a debate about whether the taxpayer made a profit or a loss.

Closer to home, this week marks the first anniversary of the nationalisation of Northern Rock. It seems to be making good progress, having re-paid about 15 million of the 26.5m the government loaned it. So why not do the same with the others?

Firstly, the Swedish and American problems were essentially single country problems. Quite unlike the present crisis, they did not cause financial contamination beyond their own borders. The disease could be isolated and dealt with.

That is just not the case with the current problem, for the securitisation of high-risk American subprime mortgages and mad dash for growth by banks such as Royal Bank of Scotland and HBOS which led to excessive reliance on wholesale market funds has spread a plague right round the world. Nationalisation as a tool for containing and curing just does not work.

Secondly, nationalisation introduces market distortions. What market, you might say. Yes, the financial market is severely impaired, but there is still a market for deposits. And because people see nationalised banks as safer places for their money than non-nationalised ones, there would be rush of money from private to state-owned banks. So there would have to be curbs on the ability of the nationalised banks to accept new customers, something that had to be enforced with Northern Rock.

Thirdly, a pro-nationalisation argument is that in today's climate, private banks tend to hoard as much cash as possible rather than lending it out. Since keeping lending going is urgently needed to keep businesses and the economy ticking over, only government ownership and direction can ensure than happens.

In fact, there is little sign of a lending strike by the banks. True, there is a credit shortage but, as I explained in a recent column, much of that has been caused by the withdrawal of foreign banks, particularly the Irish banks, from the British market in order to do what they can for their domestic economies. Recession-induced trading difficulties for companies do mean that banks will be reluctant to extend loans to firms at risk of going bust, but that, I am afraid, is a regrettable fact of business life.

This leads on to my fourth point, that when governments take control of banks, practices that maximise the return in votes begin to take precedence over those that maximise the return on capital.

Remember where this whole crisis began? Yes, in American subprime mortgage lending. And who encouraged that to happen? Yes again, successive Republican and Democrat governments wanted to see the extension or mortgages to those who could not previously afford them. True, American financial institutions were given an inch and took a high-risk mile, but no politician was inclined to question it because this was all in pursuit of fulfilling the American dream.

So if nationalisation is a bad idea, what's the alternative? I cannot see anything other than what we have now, which is creeping nationalisation where the government takes a big, but less than 100 per cent, stake.

The benefit of this is that it limits the amount of money the taxpayer has to risk in banks to the minimum necessary. The taxpayer, who has also become a shareholder, also stands to benefit by making a profit on the eventual sale of the publicly-owned shares when the banks (fingers crossed) return to health.

The size of the government shareholding also acts as a guage of a bank's health. That gives chief executives every incentive to get the business off the life support system as soon as possible. It means that there will have to be big sales of big chunks of the business. In the case of RBS, the Dutch government seems to be interested in buying back bits of ABN Amro, and there is also a lot of interest in what's left of RBS Asia. Raise a cheer when that happens, because it will mean the bank is coming off the critical list.

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