Vince Cable on bank nationalisation

Vince Cable was one of the first to call, rightly, for the nationalisation of Northern Rock - and he received justified credit for that. He has a piece in The Times today arguing the position that Ken Livingstone and Socialist Economic Bulletin have been putting forward since last autumn regarding the extreme seriousness of the economic situation and that, therefore, if a counter-cyclical increase in bank lending is to be achieved the core of the UK banking system must be nationalised now.

Vince Cable argues: 'there is also widespread scepticism about whether the Government is still on the right track - it now looks like someone giving the kiss of life to a corpse. Yet it is only a few months since the Government “rescued” failing banks with interbank lending guarantees and a £37 billion recapitalisation package for RBS/NatWest and Lloyds/HBOS.

'The new bank lending that was expected to materialise has not done so. Large numbers of perfectly sound small, medium and large companies are being starved of working capital, aggravating the recession. The withdrawal of foreign banks is clearly a factor. But, in addition, UK banks have broadly taken the view that capital should be held against future losses, a strategy that may reassure shareholders but undermines the economy.'

How the UK needs to start using its nationalised banking sector

Few things could better illustrate the way in which attempts at all costs to prop up capitalist private property are getting in the way of economic recovery than the present situation of bank lending.

In reality, in a structural sense, no banking system can function purely on a private basis in a modern economy. Every major advanced economy offers some degree of state guarantee of savers deposits. No large deposit taking bank could survive if it places itself outside such a state guarantee system in competition with banks which accept such a guarantee. That is, structurally the banking system is in a permanent state whereby distributed profits, which ultimately go to bank shareholders, are appropriated privately while potential losses are guaranteed by the taxpayer – that is the population. Such a potential clash of interest between bank shareholders and the population, the privatisation of profit and the socialisation of losses, only does not operate as long as banks remain profitable – that is there are no losses which have to be picked up by the taxpayer.

The clash of interests between bank shareholders and both the taxpayer and the needs of the economy becomes direct in a situation of economic crisis such as the present - where banks suffer major losses and the economy requires a major increase in lending to enable recovery to take place.

What occurs with a state dominated banking system can be seen clearly in China at present. There state owned banks, which form the largest part of the banking system, can, and have been, simply instructed to increase lending in order to head off recession. As a result total bank lending in China rose by 19 per cent in the year to December 2008 – accelerating from a 14 per cent annual increase in the summer. As The Economist noted: 'China is perhaps the only big economy where credit growth has heated up in recent months.' This is precisely the type of counter-cyclical policy on bank lending which is required.

In contrast, in the UK tens of billions of pounds has been pumped into banks but lending is actually falling. The reason is that privately owned banks, instead of passing on the billions in loans to companies which require them, are using them to rebuild their profitability – a large part of which will be then passed on to shareholders as increased share prices and dividends. In short, the taxpayers billions are not being used for economic recovery but to subsidise bank shareholders.

Put more bluntly we, that is taxpayers, are being robbed by bank shareholders who are taking for their own profit the funds that were supposed to go to economic recovery.

The way to break through this impasse, and ensure sufficient lending starts flowing again, is to use nationalised banks to circumvent the blockage that exists in the private banking system. This is not even an extremely radical proposal. It has been advocated by, among others, Jim O'Neill, head of Global Economic Research for the well known extremist institution Goldman Sachs – who has argued that the UK should set up a national bank. Preferable would be more than one nationalised bank as it is desirable to maintain elements of decentralisation and competition among nationalised banks – a point recently stressed by Cédric Durand of the École des Hautes Études en Sciences Sociales in France.

However the fundamental issue is simple. There is at present a clear conflict between the needs of the economy, which requires more bank lending, and the desire of bank shareholders to appropriate as much public money as possible to build up their profits. The economy is thereby being strangled by the desire of bank shareholders, and their representatives, to achieve profit.

The way out of that situation, and to prevent the economy being strangled, is to stop funneling taxpayers funds through the private banking system, where a large part, or all, of it is appropriated by bank shareholders, and instead for the nationalised parts of the private banking system to step up lending to the economy. That is what China is doing. It is what the UK should be doing.

This conflict of interest can be resolved in one of two ways. Either private bank shareholders will continue to appropriate money intended to expand lending - consequently inflicting huge damage on the economy and, due to this, undermining the support of the Labour government. Or the nationalised parts of the banking system are used to get funds flowing to companies again.

At present in UK banking the conflict between the development of the economy and a fetish of safeguarding private ownership is not a long term or tangential one. It is an immediate issue of economic recovery.

Why we should should proceed directly to nationalise the failing banks - By Ken Livingstone

The following article appeared in the Guardian's Comment is Free. It is posted here so that readers of Socialist Economic Bulletin can also follow Ken Livingstone's argument and this debate.

* * *

I have argued in the Guardian and Socialist Economic Bulletin that the international financial crisis is on such an historic scale that only action that measures up to its colossal proportions has any chance of being effective. Unfortunately, every day confirms this reality. This crisis is rooted in a severe historical overvaluation of assets in the US. As these assets are revalued downwards, to their internationally competitive levels, they destroy the balance sheets of all institutions holding them – as is indeed occurring.
The losses involved in this will be many trillions of dollars: losses on US mortgages are several trillion dollars and losses on US shares are already $8.4tn. All financial institutions that have been significantly linked indirectly to such losses will be overwhelmed by the fallout from this. Compared to the scales of losses, measured in trillions, which are involved in this process the £50bn the British government has proposed to use for the purchase of shares in UK banks is insignificant – it is equivalent to attacking a tank with a machine gun. The bullets will simply bounce off. This sum will be overwhelmed by the downward pressure on asset prices originating in the US and spreading through the world economy. A substantial part of this £50bn of risks being lost.
Indeed, the reason that the government has had to consider making such a capital injection is clear: because private investors will not risk their money in doing so. And they have good reason not to. Those investors who put £12bn into Royal Bank of Scotland and £4bn into HBOS this year have suffered very severe losses.
If it had been the taxpayer that had made this investment, the taxpayer would equally have made such severe losses. The downward movement of asset prices in the US has not yet run its course – that is, asset deflation has not yet ended. Any injection of taxpayers' money into British banks in such a situation runs grave risk of being lost.
However, while it is incapable of affecting the movements of trillions of dollars that are moving the present international financial crisis, that £50bn is a large sum compared to the scale of UK public spending, or the sums that may be needed to protect individual savers. It is therefore essential that this £50bn is not wasted in a bank "recapitalisation" programme, which the basic economic arithmetic shows cannot succeed.
To take an analogy from war, Churchill in 1940 had to take a grave decision for which he is still condemned by many in France. France requested that to attempt to stem the German advance the RAF, including forces vital to the defence of the UK, be totally committed to this battle. If Churchill had taken that decision, the RAF would potentially have suffered such losses it would not have been able to fight the Battle of Britain. Churchill took the strong and vital decision not to do so. It was necessary to prevent the weakening of the RAF in a hopeless battle and conserve its resources to win the decisive Battle of Britain.
That is why £50bn of taxpayers' money must not be committed to a battle to recapitalise banks which involves wholly unacceptable risk. Instead, news published in the Times on Friday evening showed the right way forward: "As the Treasury was set to reveal details of the British bail-out plan, sources at the IMF warned that, if this failed, then the only option would be the wholesale nationalisation of the British banking system." This was adjusted in later editions to read "officials gathered in Washington were forced to contemplate the previously unthinkable: that Britain's enfeebled banks may face outright nationalization."
This nationalisation of a number of major British banks should be carried out immediately. Some banks, notably HSBC, are able to raise private capital, if they require, to strengthen their balance sheet and should be allowed to do so. A number of others led by Royal Bank of Scotland, HBOS and possibly Lloyds TSB cannot – it is clear that the greatest financial strain now exists on the proposed takeover of HBOS by Lloyd's TSB.
Those banks that prove unable to raise private capital should be nationalised. But public taxpayers' money must not be risked in purchasing bank shares when the private sector refuses to do so. Such nationalisations would allow the kickstarting of bank lending – which the further rise in interbank lending rates on Friday confirmed will not be achieved by present proposals.
As the prime minister wrote in the Times on Friday: "The banking system is fundamental to everything we do. Every family and every business in Britain depends upon it. ... The role of banks is to circulate the savings from deposits, our pensions and from companies to those that need to spend or invest them. The cost at which banks can borrow this money directly affects the costs of mortgages for homeowners and of lending for business. This paralysis of lending from loss of confidence jeopardises the flow of money to every family and every business in the country."
Indeed, it goes without saying that the British economy cannot operate without a functioning banking system. The strongest possible banking system would be to proceed to create a strong nationalised banking sector, which will be able to restart lending.
For this reason, the government should set on one side its initial package, which is rapidly being superseded by events, and which carries unacceptable risk to the taxpayer, and proceed immediately to the nationalisation of those British banks unable to raise private capital as the most decisive way to strengthen their balance sheets and resume lending.

Riskiest banks ask for taxpayer shareholdings

As is inevitable from the structure of the proposed bank package it is the riskiest banks that are now asking for taxpayers money. According to the Financial Times late last night: 'HSBC, Standard Chartered and Abbey, the UK arm of Santander of Spain, said they would not seek government capital. Royal Bank of Scotland, Barclays and Lloyds TSB, which is in the middle of a takeover of HBOS, are seen as more likely to use the scheme.'
HSBC and Standard Chartered, because they are in origin Asian based banks, benefitting from the strength of China and other Asian economies, and Santander, because it is a Spanish bank that has historically focussed on retail deposits, are precisely the strongest banks. Royal Bank of Scotland, Barclays and Lloyd's TSB are the weakest, and therefore riskiest, banks to invest in.
This confirms that under the proposed bank finance scheme the taxpayer is being asked to invest in the riskiest of banks.
This should be rejected.

The Royal Bank of Scotland is the key

The development which almost certainly led to the government taking the final decision to launch, literally overnight, on Tuesday its financial rescue package for the banks was fear over the situation with the Royal Bank of Scotland (RBS). RBS is a giant. By assets it is the largest private sector bank in the world - its assets on 31 December last year standing at $3.8 trillion. http://www.bankersalmanac.com/addcon/infobank/wldrank.aspx
RBS therefore entirely dwarfs Northern Rock, Bradford and Bingley, or HBOS - the largest British institutional victims so far of the financial crisis.
The fall in RBS's share price between 2 December 2007 and 8 October was 87 per cent. Such a fall means the market considers that the bank is on the verge of collapse. To give a comparison, shares in HBOS, which had to be rescued, fell by 88 per cent over almost exactly the same period and Bradford and Bingley's shares had actually fallen by less when it was nationalised.
RBS, together with Lloyd's TSB and Barclay's, was one of the banks reported to have approached the government for a capital injection on Monday night. However neither Barclay's nor Lloyds TSB were in the same state of collapse of their share prices as RBS. Almost certainly, therefore, it was fear over a collapse of RBS that led the government to take action at such extreme speed.

How the new phase of the financial crisis must be tackled – by Ken Livingstone

Britain is heading into a new phase of the financial crisis. The form in which this is tackled will determine whether the government’s recent increase in popularity can be sustained. It will probably also determine the outcome of the next general election.
The step to which the government is necessarily being driven by the unfolding of the banking crisis is large scale direct intervention in the banking sector. This is what Alistair Darling is referring to when he speaks of ‘big steps which we would not take in ordinary times’.
David Cameron has publically admitted the literal financial, as well as political, bankruptcy of old fashioned neo-liberal Thatcherism by now conceding in the Financial Times: ‘It is possible to imagine the circumstances in which government injections of capital, with proper safeguards and strict conditions, may be the best way to protect the long-term interests of the taxpayer.’ On Monday 6 October Royal Bank of Scotland, Lloyd’s TSB, and Barclay’s were reported by the BBC as themselves calling for the government to put capital in the banking sector.
All this amounts to the same thing - direct state ownership in the banking system. It usually promotes clearer thought to call things by their proper name. What are the economic policy principles on which such intervention should be carried out?
This development of the open crisis of the European and UK banking system has changed not only the economic but also the political situation. If the government meets this challenge effectively it can translate its advantage over the Tories - whose support for old fashioned Thatcherism is now discredited - into a reversal of its political fortunes.
The scale of the current threatened European banking collapse greatly exceeds that of Bradford and Bingley or Northern Rock. The German Hypo Real Estate, saved only by massive state intervention last weekend, is a bank with assets of €400 billion. Fortis, which is now sundered in two between nationalisation in Holland and the takeover by the French PNB Paribas in Belgium, was even larger. In Iceland the currency has plummeted, two of the three largest banks are nationalised, and its banking system is approaching a state of collapse. The 100 per cent guarantee of deposits given by the Irish and Greek governments, followed by one for retail deposits by Germany, and now by Portugal, was forced on them by the necessity to head off the threat of a run on their own country’s banks. But it has only spread financial contagion further - to stop a run on their own banks, Ireland and Greece, in effect created a run on other countries banks as depositors switch money out of countries without 100 per cent guarantees.
As such contagion cannot be contained soon the taxpayer will bear the considerable risk of guaranteeing bank deposits across large parts of Europe.
During the first wave of the financial crisis individual European banks – Northern Rock, Fortis, Bradford and Bingley, Glitnir and Dexia – were forced to accept government bail outs or rescues of different forms. In the new phase essentially the entire banking system of countries can be threatened. As the Paulson plan will not stabilise US markets the UK government must, therefore, strategically prepare to confront the next wave of crisis. How it does so will also determine its fate at the next general election.
There is now almost unanimous agreement, including even by the government, that Labour’s response to the first phase of the economic crisis, the one of increased energy and food prices combined with economic slowdown and the collapse of Northern Rock, was insufficient or too slow and therefore led to a very severe fall in the government's support.
What was actually required, faced with increases in energy prices, was a windfall tax to redirect resources from energy companies to ordinary voters suffering from the increase in heating, electricity, gas and other bills plus an increase in taxation of the very highest paid. This would have given the government ample resources to protect ordinary voters. These measures are still required and must be accompanied by a sharp reduction in interest rates – Vince Cable was, again, right in what he said on Sunday that if the Bank of England fails to cut interest rates voluntarily, and insists on pursuing the types of disastrous policies followed by former Bank Governor Montagu Norman in the 1930s, then its independence must be revoked. Large interest rate cuts are absolutely indispensable for recovery.
Labour’s political support has significantly increased in the last few weeks as it has abandoned de facto acceptance of discredited Thatcherite dogma and has acted to safeguard ordinary people in relation to HBOS and Bradford and Bingley.
To transform the government's standing in the country this approach must continue into the new phase of the financial crisis. Reduction in interest rates is absolutely vital but it will not suffice by itself. The core of this phase of the financial crisis is how to deal with the crisis in the banks themselves.
It is clear that due to the policy decisions they made large parts of the British and European banking system will become insolvent. It is because they have brought ruin on their own institutions, while paying gigantic salaries for such incompetence, that voters regard those responsible in the banks with disdain. And it is because the Tory Party is the responsible for the Thatcherite system which permitted this that political support for this party is now starting to fall as far more fundamental issues than anything seen for decades have to be confronted.
This sentiment of voters, in fact, coincides with market economics. Financial markets are to be run by those in them bearing the consequences of both success and risk: if they take the right decisions they profit, if they take the wrong decisions they lose. If those owning banks have taken decisions resulting in the value of their equity being written off that is their responsibility. When they made profits they took huge returns, therefore those who took the wrong decisions should suffer any losses, up to going bust, is the entirely aligned verdict both of market economics and voter sentiment.
This is the fundamental principle that was rightly applied in the much applauded Swedish economic bank rescue package in the 1990s which is examined in another post on this blog. As the governor of the Swedish central bank put it this package resolutely decided to: ‘enforce the principle that losses were to be covered in the first place with the capital provided by shareholders.’ It is worth repeating the points made in that post.
Those who wish the taxpayer to subsidise bank shareholders argue that such large banks 'cannot be allowed to fail'. But this is to confuse two quite separate questions.
Certainly the deposits of individual savers in the banks should be safeguarded, and this can be done by the state, i.e. the taxpayer. It may be necessary to take banks into public ownership and ensure they function, as occurred with Northern Rock and Bradford and Bingley - and Northern Rock is now one of the safest banks in the country actually turning away depositors. But the shareholders equity should not be guaranteed. Taxpayers should not be bearing the risk of wrong decisions taken by owners of private banks.
It is said that there is an upside for taxpayers if they take a shareholding in these banks. But there is also a downside - and that is a much greater risk in the present situation. Most sovereign wealth funds of individual countries that have taken positions in financial institutions in the last period, for example, have lost huge sums of money.
In any case the downside risk of taking a shareholding position can be entirely eliminated for taxpayers and taxpayer value maintained. If the value of shares in the private companies goes down to zero when they are taken over then the taxpayer cannot lose money on that particular transaction. But if any price is paid then the taxpayer has a downside risk.
If ordinary individuals wish to invest in the shares of RBS, Lloyd's TSB, and Barclay's that is their right. But the government has no right to compulsorily force people to invest in these banks by using taxpayers money to buy their shares. And it will become drastically unpopular, and risk huge financial losses, if it does so.The government has regained popularity by its firm position on Northern Rock and Bradford and Bingley. It must not lose it by taking risks with taxpayers money that is the province of private shareholders.
Naturally an economy cannot operate without banks - and no one proposes that it should. And as the private sector cannot come up with the capital necessary for UK banks to operate, the capital to maintain the banking system will have to be supplied by the taxpayer. But the government’s popularity will be decided by the principles by which this intervention is carried out.
The economic answer is simple. First, as in Sweden, the shareholders equity must bear the losses. If this allows recovery of the banks that will be to the profit of individual shareholders. If it does not do so the taxpayer should not pick up the risk that should be borne by the shareholders. The principle must be as with the Swedish central bank crisis that any policy must: ‘enforce the principle that losses were to be covered in the first place with the capital provided by shareholders.’ Shareholders not the tax payer must shoulder that risk. The government should announce that it will safeguard the deposits of individual savers and it will step in to ensure the orderly continued functioning, including lending, of any bank whose shareholder equity has been lost – as with Northern Rock and Bradford and Bingley.
It is because overall the government has taken this route during the nationalisation of Northern Rock and Bradford and Bingley, that is that it has really followed the Swedish model, that the government’s support has revived. For the government to instead use taxpayers money to take risk on banks such as RBS, Lloyds TSB or Barclays that should be borne by their shareholders will have the effect of destroying its popularity. It is wrong from the point of view of economic principle and policy. It would, therefore, also be disastrous in its political effect.

It is up to RBS, Lloyd's TSB, and Barclay's shareholders to take risk - not the taxpayer

The BBC reports this morning that Royal Bank of Scotland (RBS), Lloyds TSB, and Barclay's have approached the government for injections of taxpayers money into their shares http. The answer should be a firm 'no'. And the reason the answer should be 'no' takes us to the core of the present financial situation.
Free markets are supposed to operate by entrepreneurs bearing the consequences of both success and risk: if they take the right decisions they profit, if they take the wrong decisions they lose. When the companies made profits shareholders took returns, and when they suffer losses that is equally their responsibility.
Market economics will be perfectly aligned with voters opinions. While individual savers' deposits should be safeguarded there should not be a safeguard for shareholders - who benefitted when the companies profited, and share prices rose, and who should not be protected from downside risk by tax payers.
It is being said that what was reported to be proposed by RBS, Lloyd's TSB, and Barclay's was an example of the way Sweden deal with its bank crisis in the 1990s. This is completely false. As the former head of the Swedish central bank pointed out, in Sweden: ‘The bank guarantee provided protection from losses for all creditors except shareholders.’ The reason for this is that it was necessary to ‘enforce the principle that losses were to be covered in the first place with the capital provided by shareholders.’
As Urban Backstrom, a senior Swedish Finance Ministry official at the time, put it: "The public will not support a plan," he said, "if you leave the former shareholders with anything."’
Or as the US International Herald Tribune stated: ‘Sweden did not just bail out its financial institutions by having the government take over the bad debts. It also clawed its way back by pugnaciously extracting equity from bank shareholders before the state started writing checks.'
It may be said that such large banks 'cannot be allowed to fail'. But this is to confuse two quite separate questions. Certainly the deposits of individual savers in the banks should be safeguarded, and this can be done by the state, that is the taxpayer. It may be necessary to take banks into public ownership and ensure they function as occurred with Northern Rock and Bradford and Bingley - and it is notable that Northern Rock is now one of the safest banks in the country actually turning away depositors. But the shareholders equity should not be guaranteed - they took the profit and they take the loss. Taxpayers should not be bearing the risk of wrong decisions taken by shareholders.
It is said that there is an upside for taxpayers if they take shareholding in these banks. But there is also a downside - and that is a much greater risk in the present situation. Most sovereign wealth funds of individual countries that have taken positions in financial institutions in the last period have lost huge sums of money.
In any case the downside risk of taking a shareholding position can be entirely eliminated for taxpayers and taxpayer value maintained. If the value of shares in the private companies goes down to zero when they are taken over then the taxpayer cannot lose money on that particular transaction. If any price is paid then the taxpayer has a downside risk.
If ordinary individuals wish to invest in the shares of RBS, Lloyd's TSB, and Barclay's that is entirely their right. But the government has no right to compulsorily force people to invest in these banks by using taxpayers money to buy their shares. And it will become drastically unpopular, and risk huge financial losses, if it does so.
The government has regained popularity by its firm position on Northern Rock and Bradford and Bingley. It must not lose it by taking risks with taxpayers money that should be borne by private shareholders.