Monday, October 13, 2008

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.


  1. "the only real solution to the current crisis is long term structural reform that promotes real wealth creation for the economy".

    Most sensible people on the right/left/somewhere else would agree with this.
    But in the short, having to act now, what better alternatives can suggest that Gordon Brown should do in the short to medium term?

    should say "what better alternatives can YOU suggest that Gordon Brown should do in the short to medium term?"

  3. I need your help in trying to comprehend the actual scale of the capitalisations going on currently.
    I am non financial/economic and therefore do not fully see the depth of the losses consequently I am struggling to visualise the extent of the overall situation.
    In general (as I see it) one of the problems (mortgages as an example) is the lending of money to people that:
    a) have insufficient income to finance the debt they incur.
    b) the value of the property is inflated so as to allow greater loans than the base value of the property would justify.
    c) the mortgagee has little or no deposit (equity) in the property hence has nothing to lose by defaulting (only amounts already paid = rent)
    Ok - this is a simplistic example but will serve to illustrate my point.

    The CRUNCH comes - there is a realisation that the loan is not going to be repaid, and that the value of the property will not cover the amount of debt incurred,
    there is some residual value in the property (asset value) and there is sufficient capital about privately to snap up these properties at fire-sale values.
    So, although there is a financial loss, the loss can be mitigated partially!

    This is where I need an explanation:

    Is the extent and volume of the losses incurred internationally (100s of billions of $) simply due to this over-lending, over-valueing, over-selling etc.. not just in housing (which does incur the losses) but in the levels of borrowings bothprivate & commercial that are being defaulted currently or are anticipated to be so, plus governmental overspending of future incomes?

    As you state at the outset of your most recent blog - "Mr Brown was said to be "genuinely shocked" when he was told how much cash was needed to recapitalise RBS" - if this is the case with a man that has been the Chancellor for the previous 10 years perhaps you can understand where I am coming from and hopefully you can produce a simplistic "Idiot's guide to the Crunch and what is happening to our future" because I find the potential scale of the disaster very difficult to comprehend in terms that relate to me and whilst I think I understand the principles you voice as to how we got here I am struggling to understand the extent and magnitude of the effect(s) being felt globally.

    I have thouroughly enjoyed reading your take on the situations past, present & future and the recommendations you make for longterm fiscal health and would express my appreciation of the amount of effort you have put in on this blog.

  4. Real wealth creation was shipped out to China long ago - and I suspect never to to return. In order to create wealth, we must have a guaranteed source and supply of cheap energy, coupled to a guaranteed supply of critical raw materials, and (home grown) educated skilled workforce - we have none of these things.

    Wealth and money are often confused, we can create pixelated money by a click of a mouse and push of a button on a printing press, creating real wealth is something different altogether.

    I think the game is up for Western capitalism, energy is in retreat as is sourcing raw materials - where is our quest for a renewed source of wealth creation to come from.

    As I said earlier, we shipped it all out to China because the bottom line was not sufficient to satisfy the engine of greed.

    The rich and the powerful can see the game is up, they want what is remaining for themselves, and it is to that end they are working toward.

    You will note in the above I make no mention of the policy of all future governments to continued mass immigration.

    Incredibly it seems there is to be no limit to the growth of Britain's population. (100 million by the end of this century) My imagination cannot cope with such a scenario, so I left it out of the equation.

  5. This whole business has led to a potential cataclysmic political sea change.

    Is neo Liberalism dead in the water?

    The ramifications to the answer to this question is mind boggling.

    If the answer is yes - What next?

  6. Very interesting blog.
    I’d like to offer a further point of reflection: while in the West we continue the “Debt Economy Delusion”, what the biggest producer of real wealth - China - will do?
    12 October, BBC News website had an article, “China agrees land reform package”.
    The article quotes Xinhua news agency:
    "The Communist Party of China Central Committee on Sunday approved a decision on major issues concerning rural reform and development," Xinhua said.
    Its commentary added: "The global credit crisis freezing up the world's finances may be a blessing in disguise for China as it aims to modify its economic structure after three decades of breakneck growth."
    My take is that, as the global crisis will restrict external demand for Chinese goods, China will expand its internal market, the biggest single market of the world.
    And what will happen then, monetary speaking? Will the Yuan increase its (now artificially lowered) value?
    And, as we are at it, what will happen to major world currencies?

  7. "I note that there was accusatory 'YOU' in the post, suggesting that it is easy to sit on the sidelines and criticise".

    Incorrect. I left the word "you" out of the first post and wanted to make the correction clear. Accusation not intended, but it does certainly look a bit funny.

    Broadly, I agree with you (except for when you state this crisis is a result of over-regulation). However the public and media expect decisive (looking) action now. I guess that's human nature. So Brown and Darling have to act.
    Should they just come clean? Do they know the extent of the situation? If yes, are the trying to hide it? Should they resign and say politicians have little power to influence this now? Then someone else would take over. What should that person do?

    I don't beleive these questions are irrelevant.
    The future is unpredictable and partly a function of what is happening now.

  8. I am nearing the end of my journey on this spaceship earth and I remember better times.

    Paradoxically, the best times I can remember is the post World War II consensus from the mid fifties to the late sixties, which saw the transition from war to the world of plenty.

    This transition was entrusted to Attlee's Labour government's programme of nationalisation of the heavy industries, from my perspective (ordinary young man) it worked, or anyway seemed to.

    I think this period was, for ordinary folk, the best attained state of society in the history of this nation. The social cohesion and stability, combined with the safety net of the welfare state, produced the nearest thing to 'utopia' I have experienced.

    Of course it was all due to the fear and threat of Soviet Communism that pushed the elites into this situation, having to buy off any likely rumblings of discontent by the masses.

    With the provision of such programmes as the National Health Service backed by a generous welfare state, prompted Conservative leader Macmillan to announce that people had never had it so good - which was true.

    By the 1970's things started to go wrong, the excess's of socialism started to take their toll.

    The elite's influence and bottom line was being eroded, which in the end prompted them (under Thatcher) to adopt neo liberal teachings to restore the elite's hegemony.

    The rest, as they is history - or is it?

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