Saturday, 2 February 2013

Capitalistic Communism: The time where all financial institutions belong to the state

The Soviet Union Saving Bank book
When the late 2007 crisis was at its initial states, very few voices of worry were heard in world. "Just another slump of the economy" most people thought. "We have seen a lot and this is nothing special." Yet, a few months later, when things began to get more serious many were concerned about the future. Then came the collapse of the Lehman Brothers investment bank, which marked an era of state involvement in the market. The US Congress allowed for a $500 billion cash injection in the market (the Troubled Asset Relief Program), with direct asset purchases through the stock market. The time of nationalizations had began.

The crisis moved to Europe in no time. It was not long before many banks were forced to seek government assistance in order to stay afloat. Her Majesty's Government in the UK acquired an 84% stake in Royal Bank of Scotland (RBS), a 43.5% in Lloyds TSB and a 43.5% in HBOS (Lloyds later acquired HBOS). In Holland stakes in ABN AMRO Bank and Fortis Bank were bought by the government, with ING Groep also assisted later, and SNS Reaal was also bailed-out just yesterday.

Spain's Bankia was another indication of the terrible state of the financial system, requesting a €19 billion bail-out on 25 May 2012. During the same time, in Cyprus, Popular Bank received a €1.8 billion bail-out making it 84% state-owned. Just as more banks are announcing their yearly results, Credit Agricole announced a €2.7 billion write-down yesterday and Germany’s Deutsche Bank posted a loss of €2.2 billion the day before. I do not have any current knowledge concerning the state of recapitalization procession in Greece and by how much the state will be involved in the banks, yet it will not be minimal. When Monte dei Paschi di Siena's audit is finished by the Italian authorities we will also have a clearer view on whether the state will assist it, as it did with Banco Popolare in 2009.

What may have caused this? The simple answer is the housing price crashes which followed housing bubbles in more than 25 countries around the world. With increased exposure to investment banking, most of the banks had severe losses during the first years of the Great Recession. Then, some had to request state assistance. With governments classifying them as "systemic" they had no option but to bail them out. This increased the national debt. Thus, they had to take some austerity measures in order to bring their deficits down. This pushed the economy further into recession and many more financial institutions were brought to their knees.

The issue is what becomes next. Will banks be perpetually in the hands of governments? Although control may not be held by the state (as in the case of British banks where the government received only preferred shares) it appears as if we are moving towards an economy where most banks are controlled by the state. I would not discuss the idea of whether this is good or bad. Yet, it would be very likely that conflicts of interest would rise in the case where governments control financial institutions. Thus, when states decide to bail-out an institution they should be sure that it will be able to pay back the hard-earned taxpayers money.

What I have never understood is why government just hand the bail-out money to the institutions which pose systemic danger instead of doing something about it. Wikipedia defines systemic risk as "the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system. It refers to the risks imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire system or market."

If we know what systemic risk is and we know which organizations are likely to produce such effects how come we are not doing anything about it? Why don't regulators split the state-owned institution into 2 or 3 (or more) smaller ones which would pose much less strain on the economy if they fail instead of just perpetuating the situation? In addition to less danger to the economy, competition will also be increased, giving more opportunities and lower prices to the consumers and even more jobs will be created. Yet, no government has taken such actions even though they have classified institutions as posing systemic danger. This would have the extra advantage (for the government) of being able to sell the stakes they currently own over an IPO to investors, thus making sure that they will receive their money back, with a profit.

One cannot help wondering what are they waiting for...

P.S. New Eurostat data suggest that the EA17 unemployment has risen by 1% over the past year. Highest increases were noted in Greece, 7%, Cyprus 5% and Spain 3%. Wondering how much time it would take for policymakers to understand that what they are doing is wrong.

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