The US government warned that failure to pass the Paulson bailout plan into law would lead to disaster. In the worst-case outcome, that could mean wholesale nationalization of the finance industry. With Frannie and AIG, and a banking system that fails without dramatic Fed intervention, the Bush administration has already made a start.
IDEOLOGY MUST GIVE way to pragmatism. Around the world, the role of the state in financial and banking markets is set to grow and the private financial services industry will shrink. Let’s just get used to it. The programme of emergency bail-outs and nationalizations will roll on for some time.
There is a basic requirement for money to move from buyers to sellers, employers to employees, savers to borrowers. Where that system is fundamentally threatened, the state must always be ready to step in. In an absolute extreme, when no other credit is deemed trustworthy to lend to, it must not just support but effectively replace the financial system.
We are not there yet.
In the US, home of free market capitalism, the debate will be long and loud over the coming months as the government seeks to sustain the financial system with public money.
The Resolution Trust Corp is an oft-cited precedent. It was set up in the aftermath of widespread failures by smaller financial institutions. It established an entire institutional infrastructure to manage and dispose on the best available terms of all manner of assets – including large numbers of buildings – that had passed into government ownership and with strict oversight. No former executive of any failed S&L was allowed anywhere near it.
The US Treasury secretary proposed a bail-out plan designed for speedy implementation, outsourced to the private sector – hopefully not those up to their necks in creating the market problems – intended to forestall a cascading wave of large financial institution bankruptcies.
Is that even the right aim, or does it risk wasting public money in preserving a rotten system or at least in prolonging the zombie life of rotten institutions whose failure might eventually follow anyway? Perhaps that pain is better taken quickly, as long as the shock does not result in complete collapse of the banking system.
Can the state devise a process of prioritizing patients based on analysis of the severity of their condition so that more can be saved, or that resources can be concentrated on saving the most systemically significant? Maybe not. And maybe the US Treasury’s stated goal of encouraging more lending is the wrong one to pursue.
Charles Dumas at Lombard Street Research finds it odd that restoration of credit flows should be a policy priority in the aftermath of the bursting of a credit boom. He says: “With a private sector gummed up with too much debt, there is no solution from creating yet more credit.” He suggests that a drastic cut in banking capacity is needed – and being delivered – and that loans will be extended at half the rate over the next five years that they were in the previous five. He says: “The next cycle is not going to be one primarily financed by debt – that has to be cut, not increased. It will be financed by equity.”
As the first version of the Paulson bailout plan limped towards its defeat in the House of Representatives vote on September 29, Euromoney could not find a single banker prepared to say that cash received from the US government for troubled assets would be recycled into new loans. Rather, banks will continue to de-lever by any combination they can manage of raising equity, reducing risk-weighted assets and even repaying their own debts. Cash received from the government will help them with the third of these.
Other options to the Paulson bailout plan