Bank nationalisations – are we really Swedes now?

February 18, 2009

Big shock! Alan Greenspan, the world’s most notorious Randian free-market guru, has endorsed the idea of bank nationalisations to solve the financial crisis.

This come-out occurs after a recent article by in Nouriel Roubini and Matthew Richardson in the Washington Post entitled “Nationalise the banks! We are all Swedes now!” which says:

“Nationalizing banks is not without precedent. In 1992, the Swedish government took over its insolvent banks, cleaned them up and reprivatized them.”

To which our Director here at ECIPE, Fredrik Erixon, a Swede, responded in an e-mail to us:

“Sweden nationalized one small, regional bank during the 1990s crisis – the big bank that had to be bailed out directly with government subsidies was already owned by the government. “

But what is it exactly about Sweden that seems so attractive? Christopher Wood, in an article in the FT last month was more explicit about the so-called Swedish model of cleaning up banks:

“Under this model banks were nationalised, fully aligning the interests of the institution with that of the taxpayer, while the depositor was fully protected. In the process shareholders were in effect wiped out, as they should be, and incumbent management was replaced, as it should be. This left none of the massive conflicts of interest, as well as perverse unintended consequences, caused by the present anomalous situation in the west where too many banks are being rewarded for failure – leading, incidentally, to a massive competitive disadvantage for those banks that managed their affairs more prudently.

A crucial principle of the Swedish model is that banks were forced to write down their assets to market and take the hit to their equity before the recapitalisation began. This is of course precisely what has not happened in either the US or Britain, where too many policy measures seek to delay asset price clearing and only add public sector debt on top of existing private sector debt. This is why the current approach in the west to the banking crisis can be compared more accurately with Japanese policy in the 1990s, and that clearly did not work. The outcome, as then, is increasingly zombie-like banks.

The ultimate endgame in countries such as the US and Britain is still likely to be full-scale nationalisation of most of the banking system, as the logic of such action finally becomes overwhelming. But it would be much better if this were done proactively rather than reactively, since it would accelerate resolution of the financial crisis. This is why nationalising the banks would also be bullish for stock markets, if not for the specific bank stocks themselves – although, obviously, there are powerful vested interests wanting to prevent such an ultimate course of action.

Another point about nationalisation, as in the Swedish model, is that it allows the government to separate the bad assets from banks’ balance sheets and place them in one big “bad bank”. This should enable whatever is left of the smaller “good” bank, which should be managed by old-fashioned commercial bankers, to become a viable private sector operator again more quickly. Another more technical, albeit important, point is that, given that many of the bad assets in this cycle will be derivative- related in some form or other, where two nationalised banks have been counterparties to the same transaction the derivative deal could be in effect terminated or cancelled because the government would be the owner of both entities. In this respect the limited number of counterparties in the $55,000bn* credit default swap market could suddenly become a positive and not, as now, a systemic negative.”

The question is really, given the size and complexity of the US’ financial sector, if the government will be able to manage all this complex mess top-down?

The policy choices that are crystallizing regarding the rescue of the banking system are very roughly the following ones:

On the one hand, the need to wipe off the bank’s bad assets, with the risk of having some banks fail. A radical solution such as proposed by Anne Schwartz however is not possible, for the systemic risk posed by potential massive bank bankruptcies. Without banks, no modern economy, basically. However, as some countries such as Germany or the US are coming up with the idea of setting up a “bad bank” to buy off the toxic assets, this core idea is now resurfacing. CEPS’ Daniel Gros explained very well what are the stakes and how a bad bank would work best.

On the other hand, there is a great aversion to let banks fail. That’s why nationalisation is a big topic right now. Given that the Lehman collapse last year only seems to have accelerated the crisis and shaken confidence even further, there is fear of an even deeper crisis if after an asset clean-up some important banks are allowed to close down. But the big risks of course are of a classic political-economy nature: moral hazard (risky behaviour by banks in the future will be encouraged, since they will act with the idea in mind that they will be bailed out anyway), and potentially a drift into some forms corruption, collusion between bankers and policy-makers, and politicisation of banking sector policies and activities. The US government will probably have the will to re-privatize banks to avert that problem. But how much damage will be done in the meantime?

The initial policy response has been the rush to save banks after the Lehman collapse. This means all forms of support to bank and bank lending, subsidies, and nationalizations. The UK has stuck out its head very strongly on those fronts. But it doesn’t seem to really be working. The more risky but in the long-term more effective policy option of cleaning up the banks themselves to have them work more effectively in the future is only resurfacing now after Hank Paulson’s (in)famous and probably not completely ripe “TARP” was drowned in the bailout package discussions.

Curious to see what will be the next episode in this decidedly epic global banking crisis.


4 Responses to “Bank nationalisations – are we really Swedes now?”

  1. Mark T. Market Says:

    Nassim Taleb spoke out in Davos about banks and the moral hazard of bailouts.

    He and Nouriel Roubini were both interviewed at CNBC recently, but soundbite journalists are incapable of handling their views sadly.

    Zimbabwe citizens know very well what kinds of horrors hyperinflation can bring, but this kind of phenomenon is considered remote from occuring elsewhere.

    Glenn Beck’s hockey stick makes me think again.

  2. Thanks for your contributions!

  3. Abunderment Says:

    Discovered your blog while looking for an interactive graphic of RTAs. You distracted me. Note I am writing from Australia.

    Australians have little interest in the EU, and have mainly forgotten about the UK since she left the Commonwealth. I am an exception, and consider Europe (and the US) to be wonderful: at once beautiful and grotesque. No metaphor could encapsulate the complexity. Behaviour seems to fit evolutionary theory rather well, though.

    I am interested in assertion “without banks no modern economy”. The term “bank” has become so loose as to be almost meaningless. Lacking experience in such things, perhaps I am missing something.

    Many things are essential for a modern economy: energy (grid), energy (oil), water, law an order, disaster responses. But it would be ludicrous to suggest that a failure of the water supply in Paris would cause Brussels to lose hers. I recall rolling power outages in the EU and US in the past caused by cascading overloads in interlinked grids, and presume “lesson learned”.

    The examples I gave are all in natural monopolies. Banking is not that. It should be, and is, competitive.

    But, again, what is banking? The most important role must be as shepherds of cash. Caring for savings of people and organisations; facilitating transactions (by cheque or electronically); acting as an intermediate between lender and borrower. It charges fees, and earns spread commissions, for doing this.

    Every country needs this. And there would be no moral hazard in bailing out such an entity were it fall – although owners may lose their assets.

    These functions are not to blame for present crisis, although the customers of many banks have been imperiled.

    Custodial functions seem to fit well. Derivatives that reduce the bank’s risk make sense. But those that increase risk seem to be contrary to other functions.

    Which leads to merchant banking functions. The use of word “bank” in merchant bank is misleading. And it does mislead – public and government ascribe cachet. Traditional banks feel envy. Allowing the two “bank” species to breed has created a range of hybrids with messed up insides.

    Enron was not saved. Those parts of banks that look like merchant banks or Enrons should not be saved.

    I agree that speculation is necessary. Derivative markets for cheeseburger buns and rocket fuel no doubt exist (separately, of course). Suppliers and Buyers can minimise risk and cost through such things. Given the market exists, there is a gain by having additional participants as speculators. Let them make hybrids. Bundle 200m dec 09 11c buns with a supertanker of rocket fuel for all I care. So long as that market functions so that counterparties pay. And the capacity for that market to infect other markets should be as close to nil as possible.

    And, to me, close to nil does not mean “in the same legal entity as a bank”! The mere idea is preposterous. Citigroup’s depositors have been unknowingly tied to toxic assets. And the US can’t realistically abandon them.

    My final observation is that this crisis has created a collective moral repulsion. Some who are horrified are also guilty – at least of naivity. Mr Greenspan will no doubt be chided by Ms Rand when he meets her in Hell. But most people are innocent.

    Commentators keep saying is that it is unprecedented.

    Well, unprecedented times call for an unprecedented response. I would like to see the appointment of some Twitfinder Generals. They would have power to seek out those who profited from transactions of obvious stupidity and seize part (or all) of assets. Structures that look bad (spousal etc) would evaporate. The “test” would be a sense of justice and equilibrium.

    Not a legal test. A moral one.

    This could be televised until ratings fall, an indication of public satisfaction.

    What do you think?

  4. Thanks a lot for this long and thoughtful comment.

    Of course, without a modern economy, no finance. So indeed you need, among many other things, all you mentioned above for a functioning market economy. But the heart of the system without which all the rest collapses is the financial system. Getting an economy going is about ensuring that there is investment. In a complex economy, a sophisticated financial system is the one that does the job as it brings together savings and economic activity. Let me simply quote Martin Wolf:

    “At its most basic, finance provides a mechanism for shifting resources from those who own them but cannot use them productively to those who can use them but do not own them. It is, therefore, the engine of a decentralized market economy. Ideas without finance are sterile. The more flexible and responsive the financial system, the better any economy will work, for the larger will be the ranges of demands that will be financed and of ideas that will be exploited. The absence of finance is crippling.”

    The problem with nationalized banking systems is that they tend to be inefficient in allocating capital to the right people. The problem is that of centralized top-down management: the information available to central “planners” is not good enough. Only people on the ground dealing with customer, investors, entrepreneurs where they are can do it. Furthermore, the government would need to rely on those same bankers to do the job anyway. What is more, commercial activity in the hands of government tends to get diverted for other purposes that breed many other problems ranging from inefficiency to inequity and potentially corruption. So nationalization of banks to solve the current crisis can at best only be a temporary measure.

    The issue with finance is that it is a system based on something very fragile: trust. Trust in the fact that others will fulfil the promises they make when they issue debt or raise equity. It’s hard to control once the money has been disbursed. Today, the problem is one of bringing back trust into the system. The complexity of banking today is based on rapid innovation to diversify the risks inherent in globalization of economic activity (e.g. currency or commodity price fluctutations, government defaults, corporate defaults in countries one does not know very well, etc). Regulation finds it hard to keep pace and to be adequate. Regulation remains largely national while economic and financial activity is global. And regulation tends to foster even more complex innovation. It’s a catch-22 of sorts.

    As to the issue of fraud (Madoff and all the other cases that are coming to the surface now), lax supervision in times of boom are alas a human, all too human failing…. It is not suprising that some have made unnoticed illicit profits in the midst of the global party. When money dries out, fraud is more easily detected, as people start asking more questions. The issue now is to ensure regulators do a better job of detecting fraud in times of boom.

    And before bashing the bankers it is also good to remember that there are many macroeconomic factors behind the current crisis: an asset bubble that burst, the effect of lax monetary policy in the US and elsewhere, excess liquidity fostered by the trillions of USD amassed by China and other (mainly resource-rich) emerging markets in the last years, an excessive current account deficit in the US, and misguided housing finance regulations in the US (remember, in 1999 the US government enjoined the two big mortgage houses to relax lending practices to “subprime” households). Real estate prices just need to go down, investors become nervous about the US dollar as the deficit widens, and interest rates go up as the Central Bank reacts to the run on the dollar, and here you go: the house of cards falls apart. The mortgages packaged so neatly in new structurd products and spread all over the world are suddenly toxic: not necessarily worthless, but nobody actually knows how much they are worht, so nobody wants to by them. Now wipe out that mess! It is indeed going to take a long time before trust in the system gets is restored.

    I am always a bit wary when one talks about “morals”. Greed is the driving force that creates riches, alas. It’s like sexual desire, another of those Christian mortal sins: but without it no life and no reproduction of the species. The issue is of channelling greed into positive and beneficial activities, and to punish bad behaviour. The problem with bank nationalization is that it doesn’t necessary do the job of averting greed. “Generals” (or any enlightened dictator of markets) are also feeble greedy human beings as anybody else, and not all-knowing, as anybody else. The myth of the incorruptible wise man – the Platonic philosopher-king – always re-emerges in crises. But it’s a fallacy. As so many a dictatorship around the world has demonstrated, either generals get corrupted, or are ousted by others, or have to end up handing the reigns back to the people.

    As to an interactive chart of of PTAs, I cannot offer you an interactive one. But there are a few fun ones here:

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