Wednesday, January 21, 2009

Buiter's Modest Proposal

It is funny how I spend a lot of my time arguing with people I fundamentally agree with. Today’s blog post by the well respected Professor Willem Buiter has really got my goat. He advocates nationalisation of the UK banking system. I think he is right.

He also advocates the scrapping of anything that looks like process. Here is his “modest proposal”:*

(1) Take into complete state ownership all UK high street banks. This has to be mandatory, even for the banks that still like to think of themselves as solvent.

(2) Fire the existing top management and boards, without golden or even leaden parachutes, except those hired/appointed since September 2007.

(3) Don’t issue any more guarantees on or insurance for existing assets - regardless of whether they are toxic, dodgy or merely doubtful. Issue guarantees/insurance only on new lending, new securities issues etc. A simple rule: guarantee the new flows, not the old stocks. This will reduce the exposure of the government to credit risk without affecting the incentives for new lending.

(4) Transfer all toxic assets and dodgy assets from the balance sheets of the now state-owned banks (or from wherever they may have been parked by these banks) to a new ‘bad bank’. If possible, pay nothing for these toxic and dodgy assets. Since the state owns both the high-street banks (I won’t call them ‘good’ banks) and the bad bank, the valuation does not matter. If the gratis transfer of the toxic or dodgy assets to the bad bank would violate laws, regulations or market norms, let an independent party organise open, competitive auctions for these assets - auctions in which the bad bank, funded by the government, would be one of the bidders. Whatever price is realised in these auctions is paid by the new bad bank to the old banks.

My only real problem here is in step 1. It is spoken with the true arrogance of someone who has never traded markets for a living.**

Now I am as sure as anyone about the parlous state of UK banking. Here are two very early posts on this blog about the state of UK banking – see this post on Royal Bank of Scotland and this one on Barclays. These posts were over six months ago. (I declare victory on them.)

Bethany McLean did a story in Fortune magazine about Royal Bank of Scotland. The story looks fantastic now – have a look. Although I was anonymous at the time (the story pre-dates this blog) I was one of the people she spoke to for that story.

But I wasn’t absolutely sure then that the banks were insolvent and I am not absolutely sure now. Indeed whilst I thought that Barclays would probably fail but that Royal Bank of Scotland might survive. The pair – long RBS, short Barclays was one I talked about but (fortunately) did not do.

The problem. There is no way that I am buying a bank stock – any bank stock – unless I know the new rules. I have no problem with nationalisation – indeed I blogged about it in the context of Norway as early as July– and the feedback was all negative – with the general view being “that it is unrealistic for America”. What I would like however is process for dealing with the residual rights of shareholders and preference share holders. [There was such a process in Norway - and one bank was only ninety percent nationalised...]

Sure: guarantee new funding. You don’t want to guarantee old funding because that increases contingent state liabilities to some enormous level. This buys you time. Use that time for a process to determine (fairly and with a right of refusal to old shareholders) the situation for new shareholders. The sort of idea that I have is that shareholders should be able tip in new capital in exchange for government guarantees on the new funding. There should be substantial new capital required (perhaps an amount determined by a third-party independent accounting structure) in exchange for these guarantees. Moreover the government should be paid an amount for the guarantees. Taxpayers take risk and should be compensate for that risk.

My guess – is that faced with a true accounting – there will be no new capital. But I really am not sure. HSBC probably could raise some. Barclays I doubt. RBS – well – it is too late for them.

A six week process which leads to nationalisation is not a major change to Professor Buiter’s modest proposal – and it can be made to fit centuries of thinking about what constitutes good government.

America’s long nightmare of bold and decisive government is over – Mr Buiter’s suggestion is so yesterday...

It is time for a nightmare of due process.



John Hempton


*For those of a less literate bent the phrase “modest proposal” has form. Jonathon Swift circulated a straight faced pamphlet (titled “A modest proposal”) that described – in harrowing terms – poverty and starvation amongst the Irish. He then – with an equally straight face – advocates that the solution is for the Irish to eat their own children. Is Buiter’s modest proposal a suggestion that the British eat their own (banking) children. If so then I have misunderstood Willem Buiter completely.

**I used the phrase “with the true arrogance of someone who has never traded markets for a living”. The people who are really good at trading markets are firm but modest. They are prepared to admit that they are wrong – and will always entertain the possibility. There is a stereotype of the blindingly arrogant bond trader – someone from Bonfire of the Vanities – or more colloquially the “big swinging dick”. Those people are dangerous in markets – and I suspect they are also dangerous giving policy advice too.

1 comment:

212213 said...

WB: "(1) Take into complete state ownership all UK high street banks. This has to be mandatory, even for the banks that still like to think of themselves as solvent."

JH: “My only real problem here is in step 1. It is spoken with the true arrogance of someone who has never traded markets for a living.**... I wasn’t absolutely sure then that the banks were insolvent and I am not absolutely sure now.”

I'm not sure where you are getting your idea that a regulator is required to prove a bank is insolvent in order to seize it. For example, I thought the FDIC could seize a bank if it determines that the bank has engaged an unsafe or unsound practices likely to cause insolvency or dissipation of assets/earnings, weaken the institution, or otherwise prejudice the interests of depositors. That's a much lower bar than proving a bank is insolvent, especially if the courts only stop the regulators if they act arbitrarily.

If the UK regulators face low evidentiary hurdles in seizing UK banks, then the regulators may have power to seize them even if they aren't "absolutely sure" the banks are insolvent.

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The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.