Banking: ‘Nationalisation isn’t the only option’…

REVITALISATION

From the desk of MD

IT could be argued that it is far easier in removing a kidney from a dead donor than it is from a live one. In terms of financial asset stripping, when American and Scandinavian regulators started extracting bad assets from their crisis-hit banking systems, in the 1990s, it greatly helped that the banks they were dealing with were either bankrupt and in the hands of insolvency practitioners, or under the control of government. Today, and since late 2008, policymakers are trying to excise toxic assets from banks that, officially, remain private and workable. Providing a resolve, though, is a much more difficult proposition.

Since the autumn of 2008, Governments around the world have poured voluminous amounts of new capital into private banks and guaranteeing their debts to protect them from further losses, in an attempt to help them raise private capital. But, continued losses have overwhelmed those initial efforts. Some banks have needed much more capital, such as the Royal Bank of Scotland, while others, like Bradford and Bingley and the Northern Rock Bank, have been nationalised outright.

What is more, the haphazard and intermittent implementation of rescue plans has kept private capital very much on the sidelines, fearful of being rapidly diluted or wiped out altogether. What is needed, colleagues say, is a more systematic approach through the creation of a “bad bank” to assume and take control of the bad assets, leaving “good banks” to resume the normal practices of banking and lending. Interestingly, according to economists, and in an Orwellian attempt to hide the nastiness, it may be known in America as an “aggregator bank”.

The terminology and language of the good and bad bank dates back to the late 1980s when America’s Mellon Bank released its bad energy and property loans into the Grant Street National Bank, which was financed, largely, with junk bonds and private equity. Private solutions alone are not feasible during crises that encompass the entire banking system because there is not enough private capital around. In the 1990s, too, the government’s of Sweden and Finland each nationalised some of the largest banks and set up “bad banks” in disposing of their assets.

Around the same time as the northern European initiative, America established the Resolution Trust Corporation in selling off the loans and underlying collateral of a vast swathe of failed savings banks (thrifts). In each case, the assets taken over by the bad bank were equivalent to around 8% of GDP, according to a study released by the World Bank (author: Daniela Klingebiel).

During this crisis, policymakers have adopted piecemeal fragments of the good and bad bank concept. For instance, in October, UBS diverted some $60 billion of toxic assets into a fund backed by the Swiss central bank. The American government is to absorb most of the losses on the $306 billion of problem assets at Citigroup and heavy losses run up by the Bank of America. The Federal Reserve is supporting the US administration in creating a facility for asset-backed securities which could relieve banks of bad loans. The British may insure banks against future losses. Notionally, the aim is to isolate toxic assets by encouraging the movement of private capital and by discouraging banks from hoarding their capital.

The immediate difficulty with an insurance scheme, as being promoted by the British Government, is the issue of market value. No market value, for instance, has been put on accrued losses. This spares banks from immediately recognising and realising their losses as they happen, leaving a smoke screen of uncertainty hanging over the system. Banks will hardly decide to sanction lending if they fear that future loan losses will deteriorate their remaining reserves and capital.

A “bad bank” might alleviate these concerns by persuading both banks and investors that the toxic debts have either been removed from the banking system, or they will as they surface. According to commentary provided by the Economist, a government bad bank can pay more for assets than a private investor because its cost of funds is irrelevant; it needs no capital and can hold the assets to maturity. These were sentiments expressed by Paul Miller of Friedman Billings Ramsey, an investment banker. It would also allow the development of a professionally uniform approach to be established in valuing and disposing of bad assets while leaving new and fresh lending decisions to be taken by the good banks.

A bad bank faces varying and different problems, the most serious of which is enabling a price for assets that both the bank and the seller can agree on. This was less of an issue in the 90s, since the bulk of assets came from banks that had already failed or were under government control. Now, though, if the bad bank were to pay above the fair-market value, it would raise the cost to taxpayers, imperil its legitimacy, and remove from the market the transparency that is desperately needed. Yet, if it pays less than fair-value, banks might even be reluctant to participate. Those that did may have to realise losses almost straight away, depleting their capital structures. Consequently, the setting up of a bad bank would require additional capital injections. In reassuring itself of the survival of the recipient bank, the government would only consider investing if the bank can simultaneously raise funds from private investors. Any bank unable to raise private capital, perhaps rendering it insolvent, would be taken over.

Critically, such steps would be very time-consuming when the crisis, such as we currently face, demands faster action. When actions are lengthy, the market might be hit with a loss of confidence at any moment. America, for example, abandoned its original plan in buying up toxic assets last October in favour of extra capital simply because the situation at hand demanded fast action.

NATIONALISATION

THE ALTERNATIVE or perhaps even a prelude to a bad bank would be nationalisation. At a stroke this would end the tensions between the aspirations of private shareholders who wish to hoard capital and lend much less, and government monitors who want banks to lend more and by modifying mortgages of those homeowners facing a difficult financial period ahead.

Nationalisation carries huge costs of its own. The world is currently awash in unwanted and poor bank assets; it could take many years for those governments’ burdened with fail banks to eventually decide that privatising their banks is the best option. As we currently see in America, and to a lesser extent in Britain, politicians become tempted to turn banks into instruments of industrial policy, propping up powerful industries such as carmakers, squeezing out other, equally, deserving recipients of much needed cash in surviving the economic storm. Politically motivated lending could result in even larger future loan losses, and private banks would be put at a disadvantage. At the other extreme, governments might be so fearful of running up taxpayer losses that they lend even less than their private counterparts. Somewhere down the line the taxpayer, too, needs to be protected in all of this.

 

© Mark Dowe 2009: all rights protected

mark.dowe@googlemail.com

The writer is a management accountant by profession, also holding an M.Sc in Geography and former pupil of Professor John Struthers.

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