Bare Talk has to interrupt regular programming to announce a special programme on the bank bailouts in the US and the UK. Bare Talk’s odyssey in Asia took him to Beijing, Shanghai and Wenzhou last week. But, given the bailout of the Royal Bank of Scotland by the UK government and the US government converting its preferred stake in Citigroup to ordinary stake to have a shareholding of 36% warrant special mention.
The mind boggles at the continued inability of the governments in both the leading champions of financial capitalism to see the futility of their attempts to shore up the living dead and the felicity with which they are able to ask the taxpayers to bear the burden first. It almost appears that they are working overtime only to make Gerald Celente a great prophet. Celente, founder of Trends Research Institute, among his many apocalyptic predictions for the US is predicting a tax revolt in the country in the years ahead.
This column tries to understand the reasons for and the consequences of the tendency to go to the taxpayer instead of the stakeholders in the company. Investors—whether equity or debt—contribute to the accumulation of assets by a corporation. They do so with a view to earning returns on their investment. Symmetry demands that they bear the downside, too. In other words, if those assets that the corporation has acquired are no longer capable of earning revenues and are deadwood, they need to be cast off and the burden has to fall on the internal stakeholders first. This is the inherent dynamic of capitalism.
Once the required commitment to forge ahead is there, private investors would gladly step in, if they see an adequate reward for risk. That is what many sovereign wealth funds thought when they first jumped at the chance to invest in US financial institutions in 2007 and in 2008. They have been hurt badly and even Warren Buffett has not escaped facing the fallout of premature investment in US financial stocks.
They are unlikely to come back to support the persistent capital requirements of the banks as they are not sure of the extent of the capital required. That, in turn, requires total transparency on the quality and valuation of assets. That remains elusive. In its annual consultative report on India last year, the International Monetary Fund (IMF) said that the Reserve Bank of India scored rather poorly on transparency. Bare Talk wonders what IMF has to say on the transparency of the British and American central banks on the true health of the entities they regulate. The lack of clarity on the valuation of assets—toxic or non-toxic—is at the root cause of the reluctance of private capital to step in and for the crisis continuing unabated.
Willem Buiter, a former member of the monetary policy committee of the Bank of England minces no words in expressing his distaste for the bailout of the banks by his government. In his popular blog Mavrecon hosted by the Financial Times, he blames it on the superior lobbying power of the financial industry compared with the taxpayers’ lonely and usually unrepresented voices. He blames corruption for the reluctance to let zombie banks meet their natural end.
Perhaps, there are other less sensational reasons at work. One is that any attempt to fully nationalize the bank, after assessing the true worth of its assets, might be considered a default event, triggering payments on billions and trillions of credit default insurance. The insurance writers might not like it and such triggers might threaten their solvency. The identity of such insurers and the notional sums involved in the credit default insurance remain shrouded in secrecy.
The second is that the regulators believe that, given sufficient time, asset prices would recover and that would make any further capital-raising unnecessary. This explanation views the problem as one of liquidity shortage rather than solvency of the banks. “Denial” is another expression for this.
The third explanation is that they know that any proper valuation of the bank assets would reveal their hollowness so thoroughly that there could be no redemption for the bank, and such a realization might threaten the financial system. In other words, prolonged medication and a comatose state are preferred to near-certain death with contagion effects thrown in, if surgery is undertaken.
None of the three explanations shines a bright light on the state of affairs of the financial system in the two countries. They also reveal the potential downside that exists for the currencies of both nations and for the banking stocks in general in the two countries.
Investors are better off betting on Asian financials that have needlessly suffered equally, if not more, despite considerably superior balance sheets, since policymakers in the developed nations appear willing to accept a lost decade as a better alternative to all others.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org