Wednesday, January 21, 2009

Binary Banks (UK bank nationalization debate)

The great British banking collapse continues apace.

Barclays led the charge this morning; off 33 per cent at one point. Lloyds too was a disaster, previously down 19 per cent.

Obviously there’s been a lot of noise from the US. A generalised market rout and a particularly rough day for the financials there after troubling losses at State Street is the proximate cause for today’s London wobble. We say “noise” though because, to paraphrase Camus (as we here on FT Alphaville are wont to do) there really is but one truly serious philosophical question right now and that is suicide nationalisation.

US vs UK public debt

The threat of nationalisation is indeed growing: it’s being talked about nearly everywhere.

But could it really happen? For starters, the effect of nationalisation on, among other things, sterling, would surely be disastrous. RBS and Barclays, in balance sheet terms, are respectively the first and third largest corporations in the world.

Then again, maybe we really are approaching a Sweden situation: the Swedish government decided in the end to nationalise the country’s two largest banks even though it meant the ballooning of the public debt.

And it’s not as if the UK hasn’t got a long historical experience of massive public debt either - see the graph on the right.

In Sweden, however, banks, had been forced into detailed disclosure of their asset values.
The difference between then and now is that with the global nature of the current crisis such detailing of - for example - Barc and RBS’s balance sheet valuations, would be impossible. It would instantly expose the fragility of the whole edifice. The bottom line is that no asset on a bank’s balance sheet is really worth much in the current climate. Just look at the recovery values on Lehman bonds.

There are more prosaic arguments against nationalisation too: a falling share price should not necessarily cause the collapse of a bank, particularly when a great part of most banks’ liabilities have been guaranteed and backstopped by governments and central banks around the world.

And furthermore, the most recent set of emergency measures - certainly those in the UK - should be hugely beneficial to the banks in short order. Never mind the changes to the BoE discount window, securities guarantee programmes, asset purchase schemes and such, one change alone should have a massive impact (more so than any other): the FSA’s amendment to the variable scalar method of internal credit risk models from point-in-time to through-the-cycle.

The effect on banks’ capital ratios from that change should be huge: massive decreases in risk weightings should free up large amounts of capital, margins will increase, and results should read better across the board. The effect is probably equivalent in bailout terms to billions of dollars of new capital, albeit without the cost of that capital.

_____

The decision then is rather stark: either the banks are going to be nationalised, and the shares are worthless, or they’re not going to be nationalised, and come the next set of results, they’ll see huge improvements in capital ratios and perhaps with that - notwithstanding a depression - some kind of recovery thereafter. (The speed at which the FSA’s change should allow banks to recapitalise could be extremely swift.)

For what its worth, we think nationalisation is the increasingly probable course. Not though, because the banks are in danger of collapse. A decision to nationalise would likely not actually have anything to do, directly, with the health of the banks and their ongoing viability as commercial concerns. The flipside to that is that protests from RBS, Lloyds and Barclays that they are not in danger of imminent collapse are red-herrings.
The government’s real choice will be made because banks will continue not to lend. They will, in duty to their shareholders, continue to rebuild capital ratios, derisk and hunker down to avoid collapse. They will, in other words, continue to fulfil their mandate as selfish corporations loyal only to their own interests.

Problem. Because the government is ultimately interested in fulfilling a mandate in the public, not private, interest.
QED, nationalisation.

Indeed, looking at things politically, there’s something of an ineluctable slide towards nationalisation as a truly viable option as the economy continues to falter. And with foreign banks too pulling the investment rug from under Britain, the slide may be a swift one.

For now though, as Simon Jenkins notes in the Guardian, the Brown government is still trying working through the banks, not around them:

Either Gordon Brown is mad or I am. His obsession with bankers has become that of an infatuated teenager. He loves them and loathes them. They taunt and tease him, and he pouts and begs and cries and loses his temper. His body craves them, but each day finds him furiously beating their chests with his fists. They have their way with him and walk away. He should forget them all and go back to his GCSE economics paper.

No comments: