Around 25 years ago when I came to the US to pursue an undergraduate degree in business, one of the first courses that I took was ECON 105 which delineated the role of government in the market.
All of the content was French to me and I found it indefensible to pore over hundreds of pages worth of dry material every week to prepare for an overwhelming and interactive lecture spanning over two and a half hours.
I failed to understand the rationale of discussing ad nauseam the value of individualism and competitiveness on a weekly basis. A few weeks into the course, and after some serious off-the-record discourse with Professor Eugene Swann, I started getting it.
By way of clarification, the focus of this piece centres not on any kind of racial slur nor on any demolition squad but on moving away from the dogma of the current system to another that can, in the interim, play its much-needed role under able guidance and then let the private sector do what it does, or should do, best.
Alan Greenspan, the former Federal Reserve chairman, who is considered a champion of free markets, recently opined that it might be necessary to nationalise — on a temporary basis — some banks to help restructure them swiftly. The current chief economic adviser to President Obama, Lawrence Summers, who once prided himself on being part of an administration that believed in staying away from financial markets, now supports massive governmental intervention, especially after the lukewarm response to the money-supply measures instituted by the Federal Reserve.
Here`s why taking over sick, zombie banks, irrespective of their size, is a good idea one, some of these banks are at a precipice already, and would fail if it wasn`t for governmental aid; these banks, in spite of the claims of being well capitalised, are still short on capital given the looming possibilities of losses down the road.
Two, helping out banks without any `skin` in the game is turning out to be a waste of precious taxpayers` funds. It has helped these banks hold on to dear life while only giving the shareholders a flickering ray of hope of redemption.
Three, injection of capital into these zombie banks, along with backstopping their eventual losses to the extent of hundreds of billion of dollars, isn`t quite cutting it when the leadership that was responsible for bringing us to the brink is still in place.
Four, if any institutional category is to be nationalised in the US, the financial companies come amongst the first to mind because of the global cobweb; a bad bank here can impact a good bank anywhere in the world.
Five, because the administration of President Obama is new and has inherited the crisis, it will be easier for it to take on the diehard conservatives, the wish to stay privately held notwithstanding.
Let it also be very clear that there is no substitute for a privately held banking system; it fosters healthy competition, thereby offering consumers several options and consistent improvement in quality. There is no doubt that, in the long run, capitalism is the best way to go.
Another compelling reason that comes to the fore is the huge banking loss that has been projected over a short period of time of $2tr, combined with the decline of the assets they hold as collateral. Even with all the treasury help in the last year or so, the banks or the taxpayers are still bearing the brunt of the crisis.
Nationalisation will not be a death sentence to the recessionary pressures but will facilitate the reversal of the downward spiral in the economy. Here`s how the process should be initiated first, make use of Secretary Timothy F. Geithner`s `stress test` criterion and put all banks through it.
It is important to use conservative measures in the calculation such as Net Tangible Common Equity (NTCE) as opposed to the equity figure which may include preferred stock which pays interest to the creditors. The capital infusion into banks by the US Treasury is a case in point; the conversion of the preferred status to common shares in the Citigroup instance dilutes common-shareholder-value but does go some way toward making it on the more stringent `stress test.`
Second, determine the ones that are insolvent based on the above set of guidelines; the treasury is looking at all banks with $100bn in assets and higher; it is important to apply the most conservative assumptions about the worldwide economy so only the most fit pass.
Third, take over the banks found to have failed the test. Unfortunately, the exercise does wipe out common-shareholder-value and the preferred stockholders get preference; FDIC steps in and pays back depositors up to the amount of the insurance limit.Fourth, once nationalised, the banks can then be split between a `bad` bank and a `good` bank, holding the respective quality of assets. The elements of the `good` bank can be coalesced into a strong banking unit and then put together for privatisation; however it may be pursued at the time. The `bad` bank will run parallel to the `good` bank and all efforts will be made by the treasury and the private sector, that may well buy into it for future returns, to bring in some semblance of viability in the portfolio.
Yes, nationalisation stifles the entrepreneurship spirit; yes, it does encroach upon people`s property rights; and, yes, it does raise anti-trust or anti-competitive issues. However, what we are looking at today is a situation that is far worse, with the potential to become even more dismal than the qualitative inadequacies inherent in the nationalisation choice. Again, if it is done well and we tread carefully while taking each step, it can bring about the lifting of the overcast sky and let some sun stream through.
Lessons are learned in history from both good and bad experiences. We will not all be Swedes if we nationalise nor will we all be socialists. The Indian and Pakistani experiences in the matter offer a negative reinforcement for the most part but we know the differing motivation behind those choices. The Chinese, in their pursuit of financial modernity, are going in the other direction and loving it. The notion is to shed the misconceptions and do what is right by the people at large, however radical it may be.
