Probably the most common argument I have heard from influential Irish commentators when they argue against nationalisation is to quickly dismiss it on the grounds that it simply does not help in “solving the problem” or reducing the cost of the banking crisis for the taxpayer. Yesterday’s Irish Times article by Scott Rankin provides one example of this argument. Let me provide three other examples. Here are two examples from Prime Time on March 19.
First, Brendan Keenan of the Irish Independent (One minute in):
I’d also be very reluctant to nationalise them because, you know, that doesn’t change the onus on the taxpayer. It just means you have to run the banks as well.
Second, from the same show (about 3.15 in), here’s David McWilliams:
It doesn’t matter whether we nationalise or not. We still have this big dilemma, which is in the last five years we lent lots of money to people in property we shouldn’t have done. Now, no matter how you skin this particular cat, you can’t get away from it. So, it makes no difference who owns it at the end of the day.
And finally and probably most importantly, here’s Peter Bacon from Morning Ireland on Thursday (about 6.50 minutes in responding to a proposal from some UCD Professor that the banks should be nationalised):
It would change the name over the door, so to speak, from private shareholder to government. The losses that I’ve spoken about will still sit on the balance sheet. My fundamental point is, look, nationalising it doesn’t change it. It might move it. It might change the name over the door. The fundamental problem is that the balance sheet of Irish banks are sorely compromised. You nationalise it and then you would still have to deal with it.
Because Dr. Bacon is its most important advocate, I hereby dub this idea the Baconian equivalence proposition. I have tried on a number of occasions to explain why the decision to nationalise or not matters greatly for the potential costs to the taxpayer. But perhaps these explanations have used too much technical banking terminology, so let me have a go using a simple metaphorical story.
Two businessman, old friends, meet in a bar. Mr. A says “Hey dude, I’m in big trouble. My balance sheet says my business is worth €20 million but actually I’ve made some really bad investments and when the accountants come in next month, they’ll see that I actually owe €5 million more than I have in assets.” Being old friends, Mr. B wants to help Mr. A. Let’s consider two possible reactions:
(a) Ok, I’ll help out. I’ll pay off your debts of €5 million. And then I’ll invest €20 million in your business to get it back in healthy shape. But, look, there are limits to my charity. You’ve run your business into the ground and I’ll only do this for you on condition that I own the new company worth €20 million.
(b) Ok, I’ll help out. Here’s €25 million for you. And you know what? I couldn’t be bothered taking an ownership stake in your company, so just carry on and keep up the good work.
Needless to say Mr. B is the taxpayer and (a) represents nationalisation while (b) represents the opposite extreme of re-capitalising without taking any state ownership stake (I know that this is not being proposed—this is an allegory to illustrate a point).
Examining this story, we can see that what is certainly true is that the amount of money paid out by Mr. B to fix the company’s problem is €25 million in both cases. It is perhaps this germ of truth that underlies the Baconian equivalence fallacy. However, to say that the Mr. B is equally well off in the two cases is clearly wrong. In case (a), bailing out his friend had a net cost of €5 billion because he now owns a company worth €20 million. In case (b), bailing out his friend cost him €25 billion.
Getting back to reality, it appears likely that our major banks are insolvent. Taking over these banks will cost the taxpayer money because we will be inheriting assets from these institutions that do not cover their liabilities (the €5 million loss in the above example). But the crucial conceptual mistake being made by BE proponents is to see the additional funds required to bring the banks back with assets above liabilities (the €20 million in the above example) as a pure cost to the taxpayer. As I outlined in my four part plan, it is crucial to realise that government funds invested in re-capitalising nationalised banks can be recouped later when the banks are privatised.
On this last point, it is probably worth emphasising that the market value at which a bank’s equity trades on the stock market is not the same as the book value equity (the book value of assets minus liabilities) that I have been discussing. Normally, banks trade on the stock market at a decent premium over book value, reflecting the fact that not only do their assets exceed the liabilities, but the holders of bank shares will be entitled to future dividends generated from profits.
It is likely that tighter regulation will mean that the premium over book value for banks will be lower in the future than the levels that prevailed in the past. But there is little reason to think that well capitalised privatised banks, cleansed of bad loans and with a strong retail base, would not sell for at least book value, and this would ensure that government re-capitalisation funds will eventually return to the government coffers.