The UK government has discovered its metaphor for the bail-out: the banks need to clean-up their balance sheets; the government is cleaning-up the financial sector ... the Augean metaphor should be suitably heroic.
But what is truly extraordinary is that it is the banks that are cleaning up, not the government. And the repeated failure of governement -- here and in the US -- to do the obvious right thing needs explanation.
Here is a good picture from Krugman representing the assets and liabilities of banks.
Here is what it says: the banks have some assets, mainly in the form of promises -- not very good ones -- to pay back some money with interest. Their extent is shown in the black bar at the top. They have liabilities: money they owe to others (debt) as well as shareholder funds.
The problem is that the black bar has shrunk so much that assets are probably smaller than the amount that banks are borrowing (debt, in red). That is a pretty good picture of a bankrupt institution. The shareholders have lost their stake and those who have lent money may have to fight it out for who gets what.
When banks are "too important to fail", it means that as the black assets continue to shrink, and as some of the debt in the red line comes up for renewal -- quite a lot of that red stuff was quite short term, so it "rolls over" (or doesn't) quite frequently -- the taxpayer has to step in to cover the funding gap.
That can happen in various ways. Direct lending; preference shares (a sort of hybrid between debt and shares); or Darling's current pet - the loss insurance scheme. Loss insurance makes it less likely that the black line will shrink further, so should, the thinking goes, encourage lenders into unforced lending to banks. The reason for that is instructive. If you lend to a bank that then runs out of money again, you risk a big loss. You put money into the venture in the past, your money is spent, so your negotiating position is gone. There is no contract -- pace the executive bonus contracts -- that someone putting money into a venture cannot demand to be rewritten.
So this is instructive. The Treasury's and Bank's insurance scheme is meant to work because investors fear the basic law of finance: new money trumps old.
But all the new money is either coming directly from, or contingent on, taxpayer funds. So why do we still have these banks at all? They are bankrupt -- and not just the ones who have taken public shareholders, also the others, benefitting from the various extraordinary central bank liquidity schemes -- so why are there any shareholders apart from us, the taxpayer? And if we owned the financial sector, what would we now be doing with it?
Already in October last year, I and others were warning that the time for recapitlisation was passed. I never expected that we would still now be tinkering with every conceivable repackaging of recapitalisation 4 months later. The advantage of temporary nationalisation, Swedish style, is that we cut through the endless wrangling over exactly how losses are going to be socialised. We accept that they are fully socialised, together with any future benefits. In a situation where month after month of insufficient measures simply makes the impact on the real economy worse, cutting through the bazaar haggling that the City is so good at makes sense.
This, just as much as Goodwin's £16m bonus for failure (Goodwin is the ex head of RBS, the biggest banking failure in the UK), needs explaining. In fact, they are related. The absence of a clean nationalisation program comes from a very disturbing alliance between bank management and government. We know how spectacularly bank managers and employees felt (and were) free from concern for shareholders. No surprise that they do not want a single activist shareholder with a different culture from them. It threatens their autonomy; it is a sort of parole regime. Goodwin's windfall, negotiated with the Treasury, shows the victory of the management over the new shareholder, but the political backlash must have Sir Fred feeling relieved he cleaned-up early.
More mysterious -- and more insidious -- is why the government has connived with bank management. Since the government has the cash the management needs to survive, why is there any negotiating power left with the banks at all?
The frightening truth is that the government does not want the responsibility for running finance. In April last year, I argued for "Responsible Recessions"---a regime in which economic policy is properly politicised, in which "responsibility hazard" (the desire for fault to be nowhere in any publicly accountable hands) is avoided. The failure of our governments to seize this moment to re-politicise economic policy is a sign of their fear and hatred of politics.
You can just imagine the Cabinet conversation. "We don't want to nationalise the banks, of course, because then everyone would think they could make a public, political claim on us. We would have to defend priorities. We would have to actually say that some project needed support while another did not. Do you imagine the nightmare that all that public thought and justification would require?"
So this is why the bank managers are cleaning up: you can trust them to exploit whatever negotiating power they have, and the fact they are doing so well against the government is a sure predictor of fear in the Treasury. The mess that is being made of the economy and Goodwin's $1m/year pension both have a common cause: Westminster's desire to avoid real politics.
