Bank Nationalisation - A Continuation of the Debt Economy Delusions

The dust is starting to settle on the first tranche of bank nationalisations, so I thought it might be worth considering what this will mean. First of all a quote from the Telegraph article (link above).

'Mr Brown was said to be "genuinely shocked" when he was told how much cash was needed to recapitalise RBS, which was ordered to accept up to £20 billion of investment, making the Government the majority shareholder.'

This is an interesting point, as it is an indication of how severe the problems are. However, my suspicion is that this is about the problems at this current stage of the crisis, not the problems that are going to emerge as the economy continues to contract. There is already talk of needing more money for the bailouts and, as more and more consumer credit, commercial debt and mortgage debt goes bad, there will be ever more need for additional financing. In other words, this is only the start.

The next quote from the same article is also very revealing:

'Banks will effectively be state-run, with Government-appointed board members put in place to ensure it once again begins lending to businesses and individual customers. Together with Northern Rock and Bradford & Bingley, the move will mean the Government effectively has four of the country's biggest lenders under its control.'

This really goes to the heart of the matter, as it is here that one of the greatest dangers lies. The question here is 'lend to whom, under what circumstances?' Aside from the long term risk of political decisions on lending (using the banks money to lend to failing 'key' industries etc.), there are more fundamental questions.

It is not entirely clear from anything that has been announced exactly what the direction of this lending might be. As such, I need to speculate on some examples. Let's start with lending into the individual consumer mortgage market. If this is the direction, then the lending will be directed at a market where the security for the loan is declining in value. In this situation, unless there is a considerable deposit required, the banks will be lending into a very high risk market. If it is consumer credit, then it is an attempt to prop up the service sector, and in doing so prolong the credit driven economy. Furthermore, if this is the intention, it is again lending into an increasingly risky market, as unemployment is now increasing very quickly, and that will mean ever more consumer debt defaults. If the lending is to businesses, once again, the risks are very significant, as the economy is entering into recession and that means an increase in commercial failures. Finally, if it aimed at inter-bank lending, it should not be forgotten that the reason for banks lending to one another is because the banks are worried that other banks are insolvent. The scale of these problems have already been revealed in the nationalisations.

Now the key question. Will this new lending be used in any significant way to build new productive assets, such as new manufacturing plants, or investment in new technologies and equipment for manufacturers? In other words, will the money be lent into wealth creation investments, or will it be used as a continuation of the debt money-go-round? Why is it that I suspect that very small percentages will be used for real wealth creation?

In short, banks are not lending not only because of hoarding of capital, but also due to the fact that there are very high risks in most forms of lending at this time. In other words, the government will be forcing the banks into behaviour which will, in the long term, just create more problems. I may be wrong about the lending into real wealth creation, but I do not think that this will be the case. The underlying idea in these nationalisations is to restore 'confidence', and by confidence the government really means to prop up the service based economy with new lines of credit.

The government is talking about re-privatisation in about five years time, and suggesting that the nationalisations will not cost the taxpayer money in the long term. The idea that the government will be able to gain any return on the investment, in light of what I have discussed, is very remote indeed. Instead, as the finance of the nationalised banks continue to decline in parallel with the economy, the government will find itself having to provide more and more capital injections to keep the banks afloat. This will be never ending, as the risky lending that is the condition of the nationalisation will just produce ever more toxic debt.

As if this were not bad enough, these nationalisations are creating a massive distortion in the banking market. In a recent article, Barclays (not one of the nationalised banks) has suggested that the nationalised banks will be hobbled by state intervention. This could not be more wrong. There is a precedent for what happens when there is an implicit state guarantee for a financial institution, and that is the example of Fannie Mae and Freddie Mac. The result of the implicit state guarantee meant that these institutions could raise money more cheaply than rivals, leading to their domination of the US mortgage market. This in turn left only high risk lending markets, untouched by the two mortgage giants (except that they bought into the risk through the 'backdoor'), for their rivals and is one of the explanations for the growth in sub-prime. In the case of bank nationalisation, the guarantee is not just implicit, but is explicit. What kind of distortions will emerge from this?

If both individuals and companies see the nationalised banks as a safer bet, it may well be that there will be a shift in deposits to these institutions, creating a chain reaction of crisis in institution that might otherwise have been healthy. It is possible to speculate that the Barclays spin on the crisis is designed to forestall such a reaction.

All of this is to leave aside the sorry history of nationalisations in general. I need not detail the long history of how nationalised industries end up as bloated corporate welfare institutions. Whilst there have been a smattering of successes, the majority of nationalised industries turn into long term drains on government finances. With the appalling state of the nationalised banks, combined with government use of the nationalised banks to achieve broader national economic aims, what chance do these banks have of ever achieving commercial success?

The most worrying aspect of this is that the idea is now spreading around the Western world. Euro zone countries and possibly the US (in a modified form?) are using the UK solution as a template for their own 'rescues' of the financial system. The idea that the rest of the Western world is following a solution like this is very disturbing. Yet again, it is a continuation of the delusions that have been driving the economic policies of the governments in the Western world. Yet again, more debt, more borrowing from the rest of the world, is seen as a solution. The idea that this is anything more than an attempt to reflate the debt based economy is the great delusion. However, the governments will point to the rise in stock markets as evidence of the success of their plans. Such a positive swing in sentiment will only be a pause, as economic reality will once again intrude on such misplaced optimism.

For regular readers, my analysis of this situation may come as no surprise. It is just a continuation of my argument is that the only real solution to the current crisis is long term structural reform that promotes real wealth creation for the economy. However, I have analysed the current crisis from a different perspective, which faces the reality of the changes that have taken place in the world economy, and this is why my analysis differs. Furthermore, I have posted many times suggesting that the US and UK economies are actually structurally bankrupt. These nationalisations have seen the government of the UK take on ever more liabilities, and this will stretch an already dangerous financial position ever faster towards the breaking point.

Perhaps the most shocking part of all of this is that the nationalisations seem to have very broad based support. The only explanation for this is an ongoing desire to stick our heads in the sand, and hope that the underlying economic problems will just to away. As I put in the title, just a continuation of the ongoing delusions.....

Note 1: I have had a comment from 'LordSidcup' (name from the Jeeves novels, I believe) asking a question as follows:

What better alternatives can YOU suggest that Gordon Brown should do in the short to medium term

My answer to this is simple. There is no short term solution. I once made a comparison with governments and King Canute trying to turn back the tides (Canute knew he could not actually do this). If I might stretch the analogy a little, this is like trying to build a wall of sand on the beach to turn back the tide. Just as King Canute knew that the tide could not be turned back, so do I. This is not 'defeatism' but recognition of the reality. Some number of posts ago, I made the comparison with a household on the threshold of bankruptcy, and how tempting it was to put off finally facing the reality with a last big loan. It is not changing the real problems that they have to face, that they do not make enough money to cover their debts and expenditure, and that they really just need to accept their real financial position. The new loan will just prolong the pain that bit longer, and leave them with ever greater problems.

I have proposed some solutions which will take a few years to really impact the system in any significant way, some of which can be found in the links at the top of the page. For the short term, there are some fast 'hits' that can be made, which may be able to help government finances. A long time ago, I started reviewing the comprehensive spending review, but only managed 1 of the 2 posts before events distracted me. One of the purposes was to look at where tax money actually goes, and to identify the most obvious areas of waste to be culled. However, in light of my not having done this, I can only suggest a look through the 'Taxpayers Alliance' website, which looks closely at waste. However, I must emphasise that these savings will do nothing to 'save' the economy in the short term, but are a good start for hastening recovery in the medium term.

The simple answer is that, one way or another, there is nothing that can turn back the tide, and governments should be concentrating on how they will manage a recovery and a return to the business of real wealth creation. I note that there was accusatory 'YOU' in the post, suggesting that it is easy to sit on the sidelines and criticise. I hope that, if you read my solutions, you will see that it is not for the lack of imagination that I offer no solution. I am not offering any soltuions because of an acceptance of the reality of the situation. The reality is -

Wealth is made - not borrowed money or something imagined into existence.

Keep this in mind, and the walls of sand being built on the beaches will be seen for what they are.