Until Lehmann Bros went down (Sept 2008) it was still just about possible (although it took a good deal of credulity) to honestly believe that Northern Rock was simply a one-off economic disaster, but once Lehmann had started the ball rolling last year it was soon unmissably obvious that the entire banking system in the developed world was infected with the same criminal recklessness with every one being insolvent because all required government action to keep them afloat whether it be direct investment or government backed schemes such as Britain’s Asset Protection Scheme. That being so, the most rational course would have been to force the banks into administration on the usual legal grounds of their demonstrable insolvency and then go for immediate and complete nationalisation with no automatic compensation to shareholders because the banks were insolvent. The state would then have had legal responsibility only for bank deposits and a distribution to shareholders and other creditors would only be made if realised assets exceeded the liabilities, a distribution which would never occur because the liabilities were so vast there would have been nothing to distribute. However, for reasons of British public confidence and international politics something would have had to be paid to the shareholders and other creditors.
This action would have immediately solved, as far as it can be solved, the problem of a lack of investor and depositor confidence because the entire weight of the British taxpayer will be behind the banks, which in an advanced economy is the best security there is. It would also, in all probability, have cost a great deal less than what the crisis has already cost and what it is likely to cost in the future. At worst it would have placed no greater burden on the taxpayer because we are already underwriting every financial institution while giving the additional benefits of allowing government to rapidly (1) ) direct lending to where it is most needed immediately, namely, business. (2) institute procedures to prevent reckless banking and (3) ascertain the true extent of the bad debts insofar as that could be done. I say as far as possible because debts can easily change their status from sound to bad as an economy worsens. In addition, many of the financial devices used to market and circulate the sub-prime debt are so complex it is possible that no one really understands them. Indeed, they may have been deliberately made impossibly complex to ensure that they could not be understood. Nonetheless, an estimate could be made which would at least give an order of magnitude of the toxic loans. For example, it could tell us that the debts were in the trillions rather than the hundreds of billions of pounds.
There is an obvious danger which would have to be guarded against. A banking system under state control would be prey to politicians manipulating bank operations for their own political advantage, for example, by extending credit freely supporters or, more broadly, instructing banks to apply looser lending rules in constituencies which they hold than in constituencies held by their political opponents. The worst case scenario is that they would plunder the banks for their own personal pecuniary advantage. The check against such abuses is unambiguous legal restrictions on what can and cannot be done by banks with thumping legal penalties for those who ignore the law and regular surveillance of the financial position of politicians and bankers.
Apart from dealing with the present crisis there are three good general reasons why banks should be nationalised. First, banking cannot simply be treated as another industry. Money is the petrol which drives the economic engine. Take it away and a society is reduced to barter. An advanced society rests on a viable currency and a stable and reliable supply of credit. It is simply too fundamentally important a matter to leave in private hands, something which is tacitly admitted by British governments for the taxpayer has long underwritten the vast majority of bank deposits. Once other restrictions were removed in the 1980s and 1990s this allowed the traditionally staid British retail banks to borrow recklessly because the lenders know the taxpayer stands behind them.
Second, the banks and their ilk are the prime drivers of the growth in the money supply through their massive expansion of credit (when a loan is made the money supply increases by the amount of the loan, because the lender still owns the money and the borrower has the use of it.) The lack of proper controls over lending has effectively privatised control of money, with the financial institutions being allowed to contaminate the currency by creating money of widely varying quality. An analogy would be with a currency based on gold with the government minting to a consistent standard, while allowing private companies to mint coins to whatever standard they chose. Nationalisation puts the control of the money supply back into public hands.
Third, all modern banking is fractional reserve banking, that is, the bank holds liquid reserves which are only a small percentage of its debt. Thus it has considerable similarities to pyramid schemes (or Ponzi schemes if you must) because both rely on the sociological trait that in normal times only a small percentage of investors/depositors will want to withdraw their money at any one time. When times become extraordinary and there is a run on a bank, the bank rapidly becomes insolvent because it has little liquidity, . the reserves held being only a tiny proportion of the total liabilities of the bank in advanced economies. This is unlikely to radically change while banks are in private hands. Hence, private banks in places such as Britain would always be very vulnerable to runs on them if the state did not guarantee most or all of the deposits. With British banks in public hands the problem vanishes, insofar as it will ever vanish, because the depositors know it is guaranteed by the taxpayer.
Bank nationalisation does not mean general state control of the economy. It is quite possible to retain capitalism for most other economic activity. It is only ideologues such as Marxists who think otherwise as they attempt to fit reality into their ideology rather than adjusting their ideology to reality. If something is practically possible – and this is – then human beings can decided that is how they wish to live. Supposed ideological necessity is no necessity at all if the ideology does not capture the mind.
Nor would the nationalisation of the banks mean that the state would be the only source of credit. Companies could still raise money through rights issues and the sale of bonds. Private equity companies could continue provided they took only money actually owned by an investor, that is, the investor had not borrowed to make the investment. Retail companies could fund their own credit schemes. Loans and investment on a personal basis could still be made.
Britain is getting the worst of all worlds at the moment and will continue to do so if the banks remain in private hands. They are propped up with country-ruining sums of money yet very little control is being exercised over them. The weasel-worded policy of “quantitative easing” – the virtual-world equivalent of printing money – which has so-far (November 2009) put £175 billion into the economy has not persuaded the banks to release the purse strings on lending to either private individuals or business. That is true even of the banks which are part or wholly owned by the taxpayer: RBS, Lloyds, Northern Rock and Bradford and Bingley, Instead the banks are re-building their balance sheets at the taxpayers’ expense and, most shamefully, massive remuneration is being paid to the people who got us into this mess. When the self-serving cries of “We must pay the market rate to get and keep the best people”, it should be remembered that not only are these the class of people who created the mess, making money through banking is considerably easier now than it was before the recession began. because so much banking capacity has been lost.
In one sense the banks cannot be blamed for what they are doing because they are on one hand being instructed by government to re-build their balance sheets to provide greater security for their future trading and on the other to lend more to businesses and loosen the reins on mortgage lending. They cannot do both, especially as much of the credit supplied in Britain prior to the recession was foreign originated, a source which has now dried up, and politicians of all sorts are yelling about the irresponsibility of 125% mortgages and mortgage multipliers of six and seven times income. The result is businesses failing for want of their previously normal credit and the housing market limping along as first time buyers are effectively squeezed out of the market by 25% deposits and 3-4 times salary mortgage multipliers and many who need to re-mortgage finding to their horror that they cannot do it on affordable terms. However, that is not an argument to allow banks to continue in private hands but an argument to nationalise, because it is quite clear that they will not behave in any interest other than their own while they remain nominally independent or are taxpayer owned enterprises waiting to be returned to private hands and still being run as quasi-private companies with, in the case of RBS and Lloyds Group, the absurdity of having shares traded on the stock exchange while the taxpayer feeds what are essentially insolvent businesses with seemingly endless and mind-shaking sums of money.
The extent to which British banks were serving their own purposes without regard to any other consideration before the financial roof fell in can be seen from their massive reliance on foreign business, viz:: “Whitehall sources said that they had discovered that some major UK lenders – including RBS, HSBC and Barclays – have had only 20 per cent of their balance sheets made up of “traditional” loans to UK households and firms. Meanwhile, up to 80 per cent is tied up in loans toforeign nationals and companies, bond issues and other investments. “ ( Patrick Hennessy, 80 per cent of bank lending ‘went overseas’ 17 Jan 2009 Daily Telegraph )
It would have been best if the banks had been nationalised right at the beginning of the present crises. However, the delay has taught the public one very important lesson, namely, that private enterprise is amoral and will always follow its own rather than the national interest.
How much would nationalising the banks cost? The honest answer should be no more than it takes to soak up their debts because the reality is that British banks were all insolvent when the rot set in after the demise of Lehman Brothers in 2008. Those banks which did not directly take taxpayers money, most notably Barclays and HSBC, survived only because of Government action such as the Asset Protection Scheme which allowed them to lay off the risk on vast amounts of sub-prime debt and the avalanche of money created through the printing of money by virtual means, otherwise known with quaint dishonesty as Quantitative Easing. As the debts of the banks vastly exceeded the assets the normal consequence of insolvency would be for shareholders to receive nothing because their shares would be worthless and there would be no money to distribute to them after paying what was realised to the creditors.
Many readers at this point will be saying, hold on, our economy is heavily dependent on financial services in general and the City of London in particular, and much of the money government spends comes from the taxes drawn from the financial services. Won’t nationalising the banks kill the goose which lays the golden egg?
The size of the financial services sector is large but it accounts for only a small part of British GDP. Estimates of its size vary but most are in the range of 7-10 percent of GDP. IFSL Research puts the contribution of financial services for 2007 (the height of the boom) as low as £7.6 billion put employment in the financial services in 2008 at 1.03 million and their positive contribution to the balance of payments in 2007 at £36.9 billion,
That leaves a great deal of other British economic activity and employment. Even with every financial institution in the country nationalised most of that banking activity would remain. In addition, the profits to be made by cautious state banking would substitute for substantial parts of the current tax revenue which is spent by government. Moreover, as economic commentators and politicians are beginning to acknowledge, Britain’s heavy reliance on financial services has caused the British economy to suffer more than any other advanced nation in this recession because the catastrophic losses sustained by the banks were proportionately larger because the banking sector was larger (Britain is the only major economy not to have come out of recession by November 2009). Arguably, reducing the proportion of Britain’s economy which is dependent on financial services would be a good thing in itself, although nationalised banks restricted to cautious banking should not get into the same sort of difficulty again.
As for the tax revenue derived from financial services, this is far from being a dominant funder of British government spending. For example, the reported tax take from the City in the financial year 2008/9 is £32.5bn (Open Europe 28 7 2009 Government reveals City firms contributed £32.5bn in tax revenue in a year) This is interesting for two reasons: firstly, the £32.5 represents only around 5% of the total UK budget spend for 2008/9 (excluding the bank bail-outs). Hence, the idea that the City is massive driver of tax revenue is objectively wrong.
Secondly, the tax paid by the City is tiny compared with the amount that the taxpayer has pumped into the banks so far – hundreds of billions and perhaps as much as a trillion. Therefore, the total amount in taxes contributed by the City since 1997 is almost certainly much less than the taxpayer has had to pump in to date. Moreover, the pain is far from over because the banks and their ilk are almost certain to have further massive bad debts to announce which will result in more taxpayer support.
If we can only guess at what the ultimate cost will be to the British taxpayer, it is clear that that the sums involved are so vast they will swallow up many years of the tax generated by the City. For example, if the £2.3 trillion national debt figure is reached, that would mean the profligacy of the banks and their ilk in Britain would have saddled the taxpayer with around £1.7 trillion pounds (the national debt before the Northern Rock crash was less than £600 billion.). Taking the £32.5 billion tax figure for the City in the past financial year, it would require approximately 52 years of tax revenue from the City at that level to meet the £1.7 trillion the taxpayer may have to service and/or pay down if the predictions turn out to be anywhere near correct.
Even the City’s contribution during the boom years is overstated, viz.: “…we are apt to attribute the sudden spurt in Britain’s prosperity in the mid- to late-1980s to a deregulated and reinvigorated City, it owed far more to the massive windfall from the North Sea. Take a look at the numbers. In 1979, when Margaret Thatcher came to power, the amount Britain owed, as a nation, was £88.6 billion. In the subsequent six years, taxes from the North Sea (which had been pretty much non-existent previously) generated an incredible £52.4 billion. “(Edmund Conway Telegraph 4 11 2009).
There is also the question of the amount of tax bankers actually pay compared with what they would pay if they were under strict PAYE, the fate of the vast majority of British employees. The Daily Telegraph reported (James Quinn 16 Oct 2009) that the tax due on a Goldman Sachs bonus pot of £13.5 billion for 2009/10 would £2.5 billion. Let’s do a bit of arithmetic. Suppose all of the Goldman Sach’s bonus pot of £13.5 bn is taxed at 40%. That would be £5.4 billion. Of course they will all have personal allowances and be taxed at the standard rate of tax up to the point where 40% rate comes into play. However, balanced against those reductions are the NI contributions, both employee and employer, and the new 50% tax band above £150,000. That duty would almost certainly substantially outweigh reductions caused by the lower rate tax band duty and the personal allowances. However, for the sake of simplicity, let us assume that the higher rate tax band and the NI c contributions merely balance out the lower rate tax and personal allowances. Instead of the £5.4 billion due at the 40% tax rate the Treasury is only slated to receive less than half that amount (46.20% to be exact).. The balance is tax avoided at best and evaded at worst. If it is only £2.5 billion the average real rate of tax on their entire earnings will be around 18% based on the entire sum being taxed at 40%., although it could be even lower in reality depending on the balance between tax allowances and the lower rate tax band and national insurance and the higher rate tax band, possibly as low as 15%. That would be a substantially lower rate of tax than a worker on average pay under PAYE. Nationalise the banks and that type of avoidance would become a thing of the past if politicians have the courage and lack of self-interest to control banking remuneration.
The City of London has not been a boon to Britain, but an albatross waiting to be hung around all our necks.