Arguments Against Nationalisation, Part 1: Politicisation of the Banks

Let’s start with what I see as the single best argument against nationalisation. The vast majority of economists get very worried when public ownership of banks is brought up because, as Frank Barry discussed yesterday, nationalised banks are particularly likely to be subject to abuse by politicians and their crony capitalist mates.

Executives in nationalised banks, who owe their appointments to the government, may find it difficult to resist pressure from a Minister to make a loan to someone that has lobbied the government or that has a political relationship with the governing party. Even beyond direct linkages with the ruling party, it is hard not to get queasy at the thought of opposition deputies castigating the government for the fact that it didn’t get its banks to lend to failing companies in their constituencies and governments giving in to avoid political flack. These pressures may lead to further bad lending and to losses that fall again on the taxpayer.

In favouring nationalisation, I don’t want to belittle these concerns. They are valid and important. I think that they need to be addressed in the design and operation of any nationalisation scheme. I would make five points on this.

First, nationalisation of the banks needs to be seen as a temporary emergency measure. We should have an explicit goal of having the banks back in private ownership in no more than two or three years time. If, as I have proposed, this is done in conjunction with an asset management agency to take bad property loans off the books of the banks, then I believe the Irish banks will be an attractive proposition for private investors within a couple of years.

Second, the banks need to be run as independent semi-state operations headed by highly independent boards of senior figures of the utmost integrity. These boards should be charged with a clear mandate to clean up the banks, improve risk management practices, and return them to private ownership in a reasonably short time frame for as high a stock price as possible. This would most likely see substantial changes in senior management in these banks. Personally, I would then incentive the new senior executives of the banks with pay contracts with modest base salaries and stock options to purchase shares in the banks when they are spun off again.

I know that some will be sceptical about how independent these banks could be but we have a tradition in Ireland of independent semi-state bodies and agencies. For instance, the Minister for Health declines to answer most questions about operational issues on the grounds that these decisions are taken by the HSE. (Say what you want about the HSE, my point is not about whether it is good or bad at what it does, just that the Minister can plausibly brush off micro-level operational issues as not being her business)

Third, it should be recognised that we are where we are and that the Bacon approach will lead to the state having a deeply entangled relationship with the banks for years. Partial state ownership is already happening and the Minister concedes that majority ownership is possible. We have also put state liability guarantees in place that could last for years. In my view, a program of nationalisation, cleaning up and re-privatisation, is likely to see a faster return to full private ownership of the banks than the government’s current approach.

Fourth, those worried about crony capitalism should consider the potential losses to the taxpayer coming from the pricing of the bad loans by NAMA. Lobbying on the part of financial institutions for a small haircut on the bad loans has already begun.  We are relying on NAMA to protect the taxpayer but we do not yet really know who or what NAMA is. The Tanaiste’s quick dismissal of opposition questions about how prices would be set with the observation that she doesn’t know anything about that because NAMA will be setting the prices, did nothing to reduce my concern about this. (There is the potential future levy to recoup costs but, as I’ve written before, this may never happen and probably wouldn’t actually recoup the full economic costs.)

Finally, it is important to recognise that issues relating to corruption and crony capitalism in banking go well beyond nationalised banks. Banks have always relied on an implicit state safety net and, as Frank noted, the Haughey-era abuses involved commercial banks. Because of recent events, the implicit state safety net of the past has exploded into an explicit blanket guarantee of all liabilities. For these reasons, whether we end up with partial state ownership, majority state ownership or full nationalisation, banks will need to be monitored as never before and their relationship with governments closely regulated by independent authorities.

9 replies on “Arguments Against Nationalisation, Part 1: Politicisation of the Banks”

I think the argument about nationalized banks being susceptible to cronyism and corruption has been thoroughly answered by the actions of the privately-held banks, which achieved sweetheart deals and cronyism with an efficiency that no publicly-owned entity could manage.

Despite political pressure from politicians and a wide number of groups with conflicting interests from the taxpayer to the banker, nationalisation of the countries banks asks the question; how will the reintroduction of the banks back to the marketplace be undertaken? The government still lives in the shadow of Eircom’s troubled privatisation and given its track record it does not instill confidence for a smooth transition.

More relevant to the present is the issue of what will the nationalisation of the banks do to Ireland’s reputation in international markets? While this nationalization has already occurred with Anglo Irish Bank, the sheer scale of the remaining banks to the size of the country is enormous and the mere utterance of the word nationalisation carries with it very negative overtones particularly to investors regardless of the practicality of it.

The pricing of the bad loans is clearly the key issue. If the government imposes the full cost of the bad loans on the banks by imposing a steep discount on the loans, it must also inject more capital into the banks to keep them liquid. Similarly, nationalisation will require the government to buy out existing shareholders which also requires paying upfront for the banks. In effect the government will take the hit either way.

Finally, as Karl and the FT have mentioned before the introduction of a levy on banks in the future will undermine the efforts of NAMA to remove the uncertainty of losses at the banks and is an ineffective attempt at recouping the cost.

For me the fundamental problem is captured by moral hazard – too big to fail and too big to bail out dilemas. Taking the first – too big to fail is a feature of Irish bankers behaviour for some time and proven to work (ICI) and last September’s quite amazing Lenihan “political captive guarantee”. Not that state ownership prevents TBTF behaviours (ask the French) yet allowing banks to remain private, provides bank management with a lever – shareholder consideration etc (losing 95% value aside). The joint stock bank model, in a crisis paralyses bankers as they focus on preserving capital – documented in evidence that credit crunch effects linger well after the initial shock and remedy. Removing the shareholder bias – protect capital at all costs – simplifies the task to “focus on creating good credits” – and get on with the job of restructuring the banking system.

The banking system is systemically important not the current ownership structure, independence or international strategies of its component banks. Nationalisation will allow for consolidation, retrenchment, transformation and focus on the national interest.

Too big to bail out means NAMA pricing will be rigged to ensure insolvency will not be an issue unless glaringly obvious (INBS & Anglo) – some would say Anglo is a mini NAMA.

The levy is a sop as clawbacks will be defeated by one fact of life. The price may be right up to the moment of transfer but immediately after as the banking relationship ceases, “willingness to repay” will evaporate. Those familiar with systems theory will recognise it for what it probably is a tipping point that external desk top analysts will have been blind to.

Nationalisation may solve the TBTF behaviours of a generation of mercenary bankers if structured and protected from crony capitalism (Bacon agues the point of a continuing stock market listing which to me seems to be impicitly acknowledging a larger state shareholding post NAMA set up). Too big to bail can be solved in the NAMA pricing mechanism: premium/discount is material to providing the capital required to support new credit creation.

I think to have a good discussion, the critical role of the banks in allocating resources needs to be fully explained. There is a lack of understanding of what banks are actually for and this is weakening the public debate.

What of the fractional reserve model and its ability to create untainted credit or fresh supply of bank money. If you were to design a core national banking system of say two to three “good” banks what would this look like? How much capital would be required and what would be the resource allocation priorties from a public interest perspective be? I do not believe the current structuration of the system is optimal and NAMA mark two may be required. How would you align stakeholder expectations of banking, in particular the public interest and private investor dynamic whilst ensuring correct resource allocation decisions were being made? Could it be that forces are acting to shrink banking’s money creation capacity too far?

Theres an implicit assumption that the refloated (after being nationalised) banks would be the same ones. I suspect that the reputational toxicity they have may make this impossible. A voucher style privtisation in part would help allay fears of eircom style issues : after all, its our money…

I think Brian Lucey is right to look at this assumption. The banking industry is going to change radically because of technological and regulatory changes which are unrelated to the crisis. For me, nationalizing the banks and selling them again is the best way to facilitate and capitalize on this radical change. Tying them up in future levies and further complicating the tier 1 and shareholding structure will just obstruct change.

I think that what Bill Hobbs says is right methodologically – we should consider what we think the banking structure is going to be, or should be for the long-term and plan towards that. However, I think that when we do this planning, we will find that the idea of national Irish banks in a european currency zone is basically silly. The bank of the future will operate in the European context, not the Irish one.

All of this means that the statement by Karl Whelan that ‘he believe[s] the Irish banks will be an attractive proposition for private investors within a couple of years.’ deserves examination. By being an attractive proposition, he means that they will be profitable. This is also the assumption that Bacon makes when he talks about the levy. But there is no reason to expect that Irish banks will be profitable, especially when they are forbidden from engaging in speculative property lending (which presumably they will). At the same time, there will be greater competition in the banking market, as marauding banks arrive from abroad and drive margins down.

Antoin – by “national” I mean regional in context – most banks are built on a core domestic base which for now remains “national” in flavour. Indeed many ownership structures are carefully designed to preserve a national bias. Cross border high street banking competition has remained largely supra-regional ie UK/Ireland, Belgium/Holland, Nordic examples.
Temporary nationalisation would provide a safe space in which to restructure banking cognisant of the evolving EU context. I agree that banking should not have inhibitors precluding the widest definition and speculative property lending is something Irish banks have a certain competence in – not all loans went bad. I’m not sure they will be precluded rather will be asked to lend into a different market for property finance. As NAMA will not be lender it will look to banks to finance realistic workouts.

Followed this thread with some interest. It seems to me that the fears of nationalisation as outlined are unlikely as this country’s track record is good. Admittedly niche players, both ICC and ACC as state companies were well run, profitable, and prudential. The TSB, although not quite the same, was an ethical and well regarded personal finance service provider while its future partner Irish Life Assurance Co was market leader in its field without there being any particular interference by the state. Indeed if the “Third Banking Force”, muted but contemptuously dismissed some 20 years ago had come to pass, we may well have had a ‘good bank’ already in place.

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