To boldly go where one must go...
UK and US edging towards partial nationalization
of financial sector
By Jon Fernquest |
[Update: A happy ending: Gordon does good]
Nationalization or socialized capitalism means the government owns a large chunk of the economy.
This is a dirty word in the US and not likely to win an aspiring president or congressman many votes in the upcoming election.
The word is a little bit less taboo in the UK.
Nationalization, or at least partial nationalization and recapitalization, may be what it takes, the bitter medicine needed to sort out the complex global financial mess that major world economies have worked themselves into and, stumbling around in the dark, can't find their way out of (See talk this week by Joseph Stiglitz).
The UK took the initiative in nationalization this week and the US is not far behind:
But it's striking to look back a month and realise that in that period the US government has become the main mortgage lender, the guarantor of the short term money market, the effective owner of the world’s largest insurance company, the potential future owner of much of the banking sector and now the purchaser of last resort for commercial paper. Since the reluctance of banks to buy commercial paper must reflect a significant probability of default, it seems inevitable that some of this commercial paper will end up being converted into claims on the assets of defaulting issuers, extending the scope of nationalisation beyond the finance sector and into business in general (Source: Crooked Timber, 08-10-08, link).
(On right photo of Spock and Captain Kirk of Star Trek fame for which the motto was the rather inspiring: "to boldly go where no man has gone before.")
Global coordination needed
A global financial crisis requires coordinated global action, observes Barry Eichengreen professor of economics at UC Berkeley and expert on the Great Depression:
"Without rapid and coordinated action by G7/8 leaders, this financial crisis could turn into a jobs crisis, a pension crisis and much more" (Source: Vox EU, 09-10-08)
A pension crisis of sorts has already hit many foreigners living in Thailand who rely on overseas investments for their income.
Some have even had to pull their kids out of private international schools.
Europe leads, US follows
Eichengreen calls on policymakers to "boldly to stabilise the financial system" The "basic elements" are:
1. A quick bank recapitalisation with global coordination
2. A guarantee of deposits and/or loans with global coordination
3. Further, coordinated macroeconomic stimulus (Read Eichengreen)
|
Several European states have already instituted blanket deposit insurance (See diagram on right and previous article).
British Prime Minister Gordon Brown was the first to move on bank recapitalization:
In a bold move to restore confidence, Britain announced an unprecedented 50 billion [pound] government lifeline for the nation's banks Wednesday that it hailed as a quicker solution to the credit crisis than a $700 billion American plan to buy impaired mortgage assets from troubled financial institutions.Britain offered banks like Royal Bank of Scotland, Barclays and HSBC Holdings up to 50 billion [pounds], or $88 billion, to shore up their capital in exchange for preferred shares. It will also provide a guarantee of about 250 billion [pounds] ($438 billion) to help banks refinance debt. The Bank of England will double the amount it lends to banks under its special liquidity plan to 200 billion [pounds] (Source: NY Times, 08-10-08).
Scaled by GDP 50 billion pounds the British plan would be the equivalent of a $500 billion plan in the US (See Paul Krugman).
The next day the US seemed to be following Great Britain's lead and recapitalizing banks in exchange for an ownership stake:
Having tried without success to unlock frozen credit markets, the Treasury Department is considering taking ownership stakes in many United States banks to try to restore confidence in the financial system, according to government officials.Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it. Such a move would quickly strengthen banks' balance sheets and, officials hope, persuade them to resume lending. In return, the law gives the Treasury the right to take ownership positions in banks, including healthy ones (Source: NY Times, 08-10-08 cited by Paul Krugman).
Tyler Cowen of Marginal Revolution is sceptical:
...say the U.S. government owns 20 percent of each major bank. Exactly what instructions do they give the management? ("Hey, guys, just get stuff going again!"?) Presumably the 20 percent shareholder wants something different, and more in line with the public interest, than the desires of the remaining 80 percent. Are we to assume that the 20 percent wins out? Can managers be sued for violating their fiduciary responsibilities? Does the 20 percent explicitly tell the managers to do something other than maximize profit? What if the 80 percent votes to override them? (Source: Economix Blog, New York Times )
Opportunity this weekend
[Update: This weekend is the "moment of truth" according to economist Paul Krugman. If financial officials of affected countries do not reach a "coordinated rescue plan" this weekend "the world economy may well experience its worst slump since the Great Depression." This weekend is important because "two big meetings taking place in Washington: a meeting of top financial officials from the major advanced nations on Friday, then the annual International Monetary Fund/World Bank meeting Saturday and Sunday" (Source: Krugman, New York Times, 09-10-08, link)]
Vocabulary:
Bank recapitalization vocabulary
recapitalisation - add money to the capital or owner's equity part of bank balance sheets to make their balance sheets strong again
strengthen banks' balance sheets - when assets shrink in value, owner's equity or capital shrinks, banks need new capital if they are to make new fresh loans to replace the bad ones and start over
taking ownership stakes - buy part of the bank, provide bank capital (recapitalize) in exchange for part ownership
shore up - strengthen and support something that is weak and about to fail (See glossary)
shore up their capital - strengthen the balance sheets of banks that are weak and about to fail by adding money to owner's equity
preferred shares - stock shares in a company that give stronger ownership rights than normal shares (common stock), higher priority claim on firm's assets if firm is insolvent and goes bankrupt
impaired - disabled, unable to function normally anymore
impaired mortgage assets - home loans that have gone into default or mortgage backed securities that include many home loans that are in default
General vocabulary
nationalization - making a company owned by business people (privately owned) into a government owned company
socialized capitalism - capitalism in which the state plays a big role
a dirty word - a bad word that it is impolite to say, a four letter word
aspiring Y - having a strong desire to achieve Y, become successful in Y
a taboo - something that people avoid doing because it is offensive or embarassing
what it takes to Y - the necessary things that must be done to achieve Y
stumbling around in the dark - bumping into things in the dark, not truly knowing what you are doing or where you are going
taking the initiative - being the first person to act (to control a situation)
a motto - a short sentence expressing a rule for sensible behaviour
G7/8 - an international forum for the governments of eight nations: Canada, France, Germany, Italy, Japan, Russia, the United Kingdom, and the United States (See Wikipedia)
boldly - doing without fear
coordination - organizing activities so that people can work together efficiently
global coordination, coordinated global action - organizing the efforts of different countries so that they can work together efficiently
macroeconomic stimulus - take action to increase economic activity through fiscal policy (cut taxes, increase government spending) or monetary policy (reduce interest rates)
blanket deposit insurance - insurance for all bank deposits
unprecedented - has never happened before
a lifeline - take action to rescue (like throwing a rope to a drowning man)
following Great Britain's lead - doing it after Great Britain did it, following their example
frozen credit markets - loans are not being made, no buying on short-term debt markets
unlock frozen credit markets - make people start loaning money again and buying and selling on short-term debt markets
resume lending - start lending (have stopped lending out of fear over what will happen)
sceptical - don't believe it will work, have doubts
fiduciary - a relationship based on trust in which one person manages money or property for another (See glossary)
fiduciary responsibilities - one of the things that must be done when you are working for another person, if trust is to maintained
X overrides Y - X is more important than Y and should be done first
the moment of truth - an important where a decision must be made quickly or there will be problems in the future
