Another week, another bank nationalised. This time it was the turn of Lloyds-HBOS to slip into public ownership as the government upped its stake in the merged banking group from 43% to as much as 75% in return for the state guaranteeing £260bn in high-risk assets. It has plenty of company. The government already controls Royal Bank of Scotland, Northern Rock and the parts of Bradford & Bingley that it didn’t manage to sell on when that bank collapsed last year.
Nor does it necessarily stop there. Barclays has resisted allowing the government a stake, but may not get through this crisis without state funds. Even HSBC is starting to look shaky: on Monday, in Hong Kong trading, its shares fell back to 1996 prices.
Yet there has been criminally little discussion about the wisdom of nationalisation. We may not like fat cat private-sector bankers with their lavish bonuses and generous pension schemes, but just wait until we see their public-sector successors. In truth, there were far better ways of rescuing the banking system – we may be paying for the mistakes of this year for decades to come.
Few dispute that the banks needed to be rescued. As much as many of us would like to see bankers pay for their excesses with their jobs and their companies, the economic consequences would be catastrophic. Too many savers would lose their money. Small business loans would be called in. Confidence would dive. But it’s a big step to take banks into public ownership. And amid the chaos of collapsing markets, the consequences have not been thought through.
The historical record is instructive. In the early 1980s, France’s President Mitterand nationalised much of the French banking system, in one of the last gasps of old-school European socialism. By the end of the decade, banks such as Credit Lyonnais had run up huge losses. Among many terrible decisions, it ended up owning the MGM film studio. In a few years, we may well see RBS bankers running around Hollywood, partying with actresses, and blowing millions on new films. There are three reasons why state-owned banks can be expected to run into big trouble.
First, without shareholders there won’t be any pressure on banks to perform. Right now, we think that means they will take fewer risks, and for the next couple of years that might be true. But over time, they will take even more. After all, they won’t be constrained by a lack of capital anymore, and they won’t have any irritating shareholders to answer to. Expanding rapidly is how you make yourself more important. So why not go as fast as you can?
Next, the banks will be subject to constant political interference. Without shareholders, there will be nothing to stop politicians meddling in their decisions. They won’t be foreclosing on dud loans, certainly not if there is a factory or call centre at stake in a marginal constituency. They will be dishing out money to ‘national champions’. Worse, over time, a crony culture will build up. Property developers and industrialists who want access to loans will need to get the bankers on board. That will mean getting politicians on side as well. Expect to see a big increase in party donations, and generous non-executive jobs for even the most brain-dead backbenchers. It won’t be very efficient. Nor will it do anything for the honesty of public life.
Lastly, there won’t be much in the way of innovation. With the bulk of our banking system state-controlled, there won’t be any competition to spur new thinking. For now, we have had too much financial innovation. But as we emerge blinking out of the recession, we’ll need finance to repair battered balance sheets, and to pay for mammoth government deficits. We’ll need more clever financing, not less.
It’s naive to think state-owned banks will allocate money any better than private-sector ones. They will still blow it – just in different ways. Bankers like nothing better than spending other people’s money. Now, courtesy of the taxpayer, they have just been offered a bottomless pit of the stuff. Don’t expect the results to be anything other than very ugly.
There was a better way. The government could have set up a series of so-called ‘bad banks’: one for each institution in trouble, or one for each class of asset that had turned sour. The ‘bad banks’ would buy all the troubled loans at par, using money printed by the Bank of England if necessary. It would hold onto them until they recovered in value – as many mortgages will eventually, for example – or until they had been deemed worthless.
The short-term losses would be horrendous, and would be shouldered by the government. But the taxpayer is taking on terrible losses anyway. Against that, the country would be left with a clean banking sector, with the toxic loans taken off its books, which could then start lending again and competing with each other. The slate would have been wiped clean and a fresh start could have been made. Doesn’t that sound better than a group of state-owned banks stumbling inevitably towards the next disaster?