The banking crisis: “classic” or “creeping” nationalisations?

The crisis of the banking sector is intensifying. Government interventions on both sides of the Atlantic are accelerating and increasing in numbers. The objective is safeguarding the financial system, cornerstone of policies aimed at restoring consumer and investor confidence on which economic recovery is based.


In the early stages, this task was mainly assumed by monetary authorities who, from the summer of 2007 onwards, flooded the market with liquidity, substituting for the inter-bank market as banks lost confidence in each other as the mounting losses attributable to the “subprime” crisis came into focus. Interest rates were slashed, first in the United States followed by the United Kingdom, Japan and other countries and finally joined by the ECB from October 2008. While the ECB delayed cutting its official rate due to the persistence of inflationary pressures up until July 2008, it acted, nevertheless, with great determination from the summer of 2007 onwards by being among the first Central Banks to show greater flexibility in setting eligibility criteria for collateral and extending the maturity of its interventions.


These efforts proved, however, insufficient to restore confidence, leading to a credit squeeze which propagated the financial crisis to the economy in general. As of late summer 2008, Governments faced the need to act both on the legislative front and through direct financial interventions.


A first set of measures, agreed at European level, included a commitment to extend the amounts covered by national deposit guarantee schemes from €20,000 to €100,000. The aim was to avoid massive withdrawals by depositors. This proved successful as the vast majority of deposit and savings accounts held by citizens were covered by the new ceiling. Let us take a closer look at this measure:


Some analysts concluded that Governments were assuming a liability that they would be unable to meet without dire adverse consequences: for instance, in Belgium, the potential guarantees amounted theoretically to some €400 billion compared with the current level of the national debt amounting to around € 250 billion!


However, this State guarantee – a measure aimed primarily to have a psychological impact – was coupled with a second commitment vowing to ensure that no major credit institution would be allowed to fail. This latter commitment ensured that payments under the guarantee scheme would never occur as the primary condition of execution (declaration of bankruptcy) would not be fulfilled. By guaranteeing the “solvency” of banks, Governments were able to protect all savers and depositors as well as other creditors of financial institutions at the lowest possible cost while avoiding a systemic crisis of the banking sector.


Politically speaking, this decision was wise and should be thoroughly applauded. Its aim was to “save the financial system” and not to “save the banks”. The confusion surrounding this distinction, often made deliberately, can be very dangerous: many political actors, but also some economists, insist on a quid pro quo between the “rescue of the banks” – with tax payer’s money – and an obligation for the beneficiaries to further extend credit to support economic recovery.


This leads to an alternative:


-          Either, after government intervention, in the form of recapitalisation and/or extension of guarantees, banks implement sound lending criteria (often overlooked prior to the crisis such as in the “subprime” market) and remain in compliance with the existing regulatory framework (Basel II).  Such a stance creates nearly automatically a credit squeeze because the crisis is itself a major factor in weakening the credit worthiness of borrowers and/or in provoking an increase in margins/guarantees to compensate for the increased risk.


-          Either the banks bow to the imposition of a “legal” credit framework imposed by the Government. In this case it is to be expected that the banking sector will find it difficult to improve its deficient capital structure and that new public support measures will be required triggered by the commitment of the authorities to prevent any bank failure.


Politically it is clearly the second option that is the preferred choice which is perfectly coherent with the overall priorities of Governments. It implies, however, major consequences on the conditionality on which Government intervention must be based, the cost of which is ultimately born by the tax payer.


These injections (including those already granted) must be structured in such a way that their repayment and remuneration has absolute priority over any distribution (dividends) to ordinary shareholders and it also calls for a limitation in director and staff compensation as long as the institution continues to benefit from Government support. This is the path followed, mainly in the United States (and more recently in the UK), in the successive rescues of Fannie Mae, Freddie Mac, AIG, Bank of America, Citigroup etc. It amounts, actually, to a “creeping” nationalisation in all but name. Indeed, as a result of the harsh and fully justified conditions imposed by the authorities (the alternative being immediate bankruptcy), shareholders find their stake being diluted at every successive stage of Government support.


Such a pattern has other significant benefits: it avoids the lengthy procedures required by a “classical” nationalisation which include an “evaluation” and “fair compensation” of shareholders at a time where clearly the market turmoil, does not allow the conduct of such operations in an objective manner. Furthermore it encourages operational continuity, avoiding Governments having to assume managerial responsibilities for which they are ill equipped. Finally, it greatly facilitates the Government’s exit (if the basic structure has survived) avoiding a lengthy and expensive “privatisation” procedure.


Had such a pattern been followed in the Fortis case, right from the outset end September, by securing the intervention of the three Benelux Governments though the pledge of Fortis Holdings assets, the opportunity for disruptive actions by shareholders would have been largely curtailed. It would also have avoided, for the Belgian tax payer, the risks that are associated with a possible withdrawal of BNP from the deal which should not be underestimated in light of the significant further deterioration of the banking sector as a whole since early October when the agreements were reached.


In conclusion, it is particularly objectionable to play the “soccer’s apprentice” in such a sensitive domain through ill supported declarations which often implicate without sufficient discrimination the actors that on the front line. The citizen is easily misled by an oversimplification of the challenges to be faced and the mirage of miracle remedies proffered by ill informed politicians or lobbies of all kinds, defending partisan or private interests.


Overall, Governments have shown remarkable poise and avoided, to date, the systemic collapse of the financial system. It is and should remain their first priority. If it entails the temporary “nationalisation” of large segments of the banking sector, it is a political choice that is fully coherent with the efforts to stimulate the economy alongside appropriate fiscal and investment measures.


However, despite the huge amounts involved in the stimulus packages announced by Governments around the globe, it is far from certain that they will be sufficient to prevent further economic contraction. Indeed, the financial flows initiated through the process of debt reduction worldwide seem, for the time being, to overwhelm all efforts to stimulate economic activity, making the spectre of deflation predominant.

Whatever the outcome of this tug between depression (and its ensuing deflation) and recovery (and its ensuing danger of hyperinflation) there is a very high price that will have to be paid. It is bound to lead to a profound mutation of the social economic as well as geopolitical environment.


Brussels, 18th January 2009

08:56 Écrit par Paul N. Goldschmidt 13 Ave. Victoria 1000 Bruxelles dans Général | Lien permanent | Commentaires (0) |  Facebook |

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