For those who have followed the credit crisis, it is becoming clear that the western world is on it’s way to do a mass nationalisation of the banking industry. That will save quite some jobs, and hit investors, as their shares in many banks become worthless. But it is also an effective “Greenspan put” on reckless financial behaviour. Will financiers learn from it?

A second effect will be that governments absorb “toxic waste” in those financial institutions. They may split the nationalised banks in a healthy part and a mortuarium bank, containing the toxic waste, and in a few years bring the healthy parts back to the stock market, or sell them to other banks. The end result is thus that taxpayers end up with the “toxic waste” and only may hope for the best.

The prime motive to nationalise the banks, insurers and other financial institutions, seems to be that they are “too big to fail”. The logical conclusion then is, that a healthy financial system should contain far more and much smaller banks. A non-interventionist approach would create a flurry of defaults and a break-up in parts of the major players, who sell out their subsidiaries and divisions to raise money. Nationalisation blocks that restructuring process, at most one get a political decision to scale down some of the big firms.

A different approach might be that governments do not engage in “saving the system”, but instead create more redundancy and more resilience in the system, by establishing new banks, that are on a sound financial footing and legislate that in two or three years the shares in those new banks will be given to the taxpayers.

Those new banks could start frome a clean slate. Setting up an Internet banking portal with modern IT and without any legacy. Also, if they want to be in the bricks-and-mortar business, now, during an economic crisis, is the time to rent offices and retail space on the cheap with multiyear contracts.

Off course, creating such banks requires some time, but with massive layoffs and bankruptcies in the financial industry, populating their workforce with qualified workers will be rather easy. As an employer the new bank can establish labour contracts with more normal remuneration and bonus programs.

When the general public trusts these new entities and mistrusts their current bank, there will be a rapid shift of accounts to these new entities. This has a major beneficial effect, that it is exactly the opposite of the “Greenspan put” and a well functioning bank with normal remunerations has a strong disciplinary effect on salaries in existing banks.

The trusted new banks can have their IPO in a few years. E.g. the government can sell 10% of the stock on the market and put the proceeds in the bank as additional capital, while distributing 90% of the shares among the taxpayers. They then can decide to hold their shares or sell them on the stock market.

When the general public does not trust these new sound banks, the existing banks will continue to function with large market shares. As that occurs, investors are reassured that the existing players are competitive and can take a more fundamental and long term view on their viability.

Creating sound new banks and putting them on the market, is like creating an entity that constitutes the Tobin-Q for the financial industry in practice. We have seen that after the 2000-2001 Internet and Telecom crash, the assets of the failed companies were often snapped up at valuations far below their Tobin-Q. The problem with banks and financial institutions is that their main asset today is trust, a non-physical entity. So the ultimate policy issue is to re-establish a value on what constitutes a trusted bank.

Governments who have nationalised their banks, will have to think through how to privatise them in a few years from now. Existing banks are however institutions loaded with legacies in organisational culture as well as old IT. People in these banks now experience the “Greenspan put” as they have been saved.

There is a huge risk that due to broad stroke policy deals with various stakeholders, we only get the return of existing entities, or even worse, a far more concentrated market as policy makers start to create “new big entities” by merging banks. That is effectively a new bank that is even more prone to be considered “too big to fail”. It might also be an attempt to gain some additional profits for the state in the prospective IPO from a more concentrated market, e.g. creating a few national champion.

Anyone who studied a bit the functioning of oligarchic markets would grasp that a privatisation of national champions constitutes another burden on the average citizen as well as businesses in the non-financial economy. Sound and save banks, but less banks, may provide the optical illusion of refound stability, due to a more concentrated oligopoly, but comes at a very substantive long run cost to the average citizen. It relaunches inefficient institutions, while providing less choice and does not confront the people who work inside those businesses with more competition.

The purpose of this first blog entry was to sketch an alternative that is not yet on the policy tables of people who discuss the future of the banking industry. It is meant to sketch a pro-competitive approach that goes to the heart of the problem, the fact that there are too many banks that are considered “system banks” and “too large to fail”.
There is a huge risk that politicians, after they have nationalised their banks, will proceed in an anti-competitive mode.

The genuine economic problem of the financial sector today is that they do compete, but are “too protected”. This has allowed them not only to take too much risk, but also to pump up staff salaries far above other sectors of industries and collect a much larger share of our societies’ economic rents than justified by their contribution in a hypothetical unregulated world, where they had to take all risks into account and would not be able to rely on a “Greenspan put”.

Regulatory protection also allowed them to hire a lot of talented people from other sectors of society e.g. math, physics and computer scientists, who would otherwise be working in the science and technology intensive sectors on very different innovations for humanity. The social and economic burden of the regulated financial sector is grossly underestimated.

Since 1990 the first job salaries of economics and business administration majors have grown much faster than those of other academics and in particular engineering and science majors. As people with academic degrees are not stupid, a substantive number of them has switched carreers to the financial sector.

In 2004 a group of economists at the Netherlands Bureau for Economic Policy Analysis misinterpreted the growing salary gap between economists and people with science and technology degrees. They did rightly observe that science and technology jobs experienced more competitive pressure from India and China (ICT is now known as an abbreviation for India and China Technologies). They misinterpreted however the decision to switch to the financial sector by many with good math and calculative skills. This was due to overprotection and screening from competition in those financial industries, resulting in finance specialists experiencing a too low risk of losing their job, while taking in an above long run average amount of gross economic profits.

It is now wise for economists to do a thorough introspection whether they did not had a blind spot for the failings of the industry most close to their profession and prescribe to the financial sector the same medicine, they have recommended for many technology driven industries: more competition and breaking up of monopolies and tight oligopolies.

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