National Rock
Oh, how I wish I were a British taxpayer, so my government could also buy me plums like Northern Rock. The bank says it’s “business as usual”. Of course. What bank doesn’t say that? I’m sure all blue-blooded Englishmen are just rushing to open accounts and refinance their mortgages.
The UK government says “In the current market conditions we do not believe that they (the bids for the company) deliver sufficient value for money.” Effectively, Richard Branson’s bid (and that of management) condemns the plum as a lemon. He wishes the bank (fare-)well.
Nevermind wishing I were a British taxpayer (after all, my government owns lots of juicy fruit, such as Eskom, parts of Telkom, Infraco, and South African Airways). What I really wish is that I were a British banker. Imagine. Set up a bank. Take whatever risk you like. Undercut your rivals. Crush them! Be daring, be bold! Because if you win, you’ll be up to your eyeballs in fame and fortune. And if you lose, well hey, Gordon Brown’s party will take the disaster off your hands. What a steal!
I’d love to hear why the British government does not think nationalising Northern Rock introduces moral hazard throughout the British banking sector — why it doesn’t think this decision will poison the quality of risk-taking in the UK.
What a sad day for the City.
Ivo, do you know if the failure of Northern Rock would have endangered the whole UK financial system? If so, then maybe the intervention was justified.
As long as Northern Rock shareholders lose all their equity capital, taxpayers should be supportive of Brown holding out for a better price. Perhaps one of those aspiring “1001 Arabian Knights” (TM) would be willing to throw a few loose oil-pounds around?
It may have. I doubt it, but let’s say it would have. In that case, you could indeed argue that the intervention was justified.
But that’s a long way from nationalising it. Now, instead of a better price, the government got no price at all, and doubled the risk to taxpayers. The consequences are far-reaching. Other banks will be at a competitive disadvantage. There’s the moral hazard of affirming that the government will underwrite any management failure at a bank. There’s the obligation on government to make it profitable. It can’t take any risks on that score, as a private investor would.
They should have sold it directly out of administration, rather than nationalising it for the long term. This sets an awful precedent that will do great damage throughout the British economy, and put the British taxpayer, involuntarily, at great financial risk. If you ask your average British family how they’d rather invest £3 500, I reckon you’ll get a few answers that are not “bail out a dodgy business”.
Did you read Will Hutton’s piece in the FT yesterday? http://tinyurl.com/2y78va
“It is because a failing bank needs public guarantees and perhaps even public ownership, with the consequent potential market distortions, that the authorities must prevent it failing in the first place. That, in turn, requires recognition of the symbiotic relationship between enterprise and state, which is even more obvious in banking than in other industries. The solution will require more comprehensive deposit insurance, pro-active regulation, stronger corporate governance and some limit to the irrational bonuses that have provided an incentive for such reckless behaviour. It may be a conversation that few in the political class and even fewer in the business class want to have. But it must be had; and with no ideological blinkers.”
Your thoughts?
Hutton would accuse me of wearing ideological blinkers, but I suspect he is a little blinkered himself, by the perceived importance of various industries, which he believes deserve government protection.
Hutton appeals to fact that “very few successful businessmen would claim otherwise”, but he falls into the usual trap of identifying businessmen with free marketeers. Many are not, because many desire government protection, subsidies, taxbreaks or safety nets. What businessman wouldn’t prefer to have the risks he takes underwritten by the largesse of forcible taxation revenue?
I think there would be better ways of avoiding runs on banks, stopping them, or preventing them from spreading. I’m no expert, but I don’t think state-funded depositor insurance, state-funded lifeboats or outright state ownership of banks are the only solutions to this problem.
All state protection does is to remove the risk from an industry, and to transfer it to taxpayers. In principle, this is both unsustainable and unjust, since the taxpayer cannot afford to underwrite all risks, and should not be expected to accept losses they did not incur themselves. In practice, it introduces the moral hazard of encouraging anyone else in those protected industries to take larger risks than they would have if only investor capital was at stake.
The level of regulation Hutton advocates, no matter that he claims otherwise, takes several step towards socialism. Few would dispute that an economy cannot afford a lot of socialism. Why would it benefit from just a little socialism?
For the same reason that a little alcohol is quite enjoyable (and possibly healthy), but overindulgence will kill you!
If “a lot” of regulation kills an economy, how about the other extreme, zero? Wouldn’t that also kill an economy, or at least turn it into anarchy (your Somalian example notwithstanding)?
So, I’m sure we can agree that “a little” regulation would be optimal, we just need to work out where to pitch it. Since most (if not all) taxpayers benefit from a sound financial system, they should be happy to fund the costs of making it so.
There’s a good reason for thinking that “where to pitch it” falls several miles short of nationalising a failing bank.
My own position defaults to “protecting property rights and enforcing contract law” as the sole mandate of government, if only so we don’t have to shoot each other to protect our own property and enforce our own contracts. Any regulation beyond that requires a strong positive argument, and even then, I’d wager that in most cases the net cost exceeds the net benefit.
You say taxpayers benefit from a sound financial system, yes, that’s true. But that doesn’t justify any cost. Nationalisation had nothing to do with the soundness of the financial system, anyway. The original rescue was about the soundness of the financial system. The bank could have been wound down in a perfectly orderly fashion, as happens to any other failed business. Nationalisation wasn’t the only option here, and the impact on the broader economy of this step is a cost well beyond the mere value of National Rock. Well beyond what taxpayers were told to expect (or, for that matter, can predict). In fact, it breaks the assumptions on which risks are evaluated against reward.
By underwriting risk, you encourage more risk, which is exactly what caused this problem, and exactly what government policy (if any) should want to discourage. It’s very similar to price controls, actually. Governments want to make something available to more people, so they cap prices, but the result is that less of it is produced, so a shortage occurs, so fewer people end up having access to it. The effect is exactly the opposite of what was intended, because an artificial distortion is created in the market.
That is the problem here. Even if intervention was justified, the wrong intervention took place.
Points well taken.
I don’t really know enough about the details of the Northern Rock case to voice a strong opinion one way or the other — I’m more interested in the general lessons we can learn from this and your other recent examples.
Something I’ve been meaning to ask… Are you in favour of a “night watchman state” simply because you think that Government and its various functions are by definition inefficient, and therefore too costly?
What if Government can be run like a Google or Microsoft, where employees are amply rewarded for innovation and efficiency? I’m not suggesting this would be easy to implement in practice, but if it’s theoretically feasible, surely it merits consideration?
Yes, nightwatchman state puts it pretty well. I’d like to see anything that can be done in a private, free market, done so. (It is important to note that private is a necessary condition, but not a sufficient one — it must be possible for competition to arise.)
The comparison between government and private companies doesn’t work well, though. A government agency shouldn’t exist to make a profit, it doesn’t face competition, and “customers” don’t have a choice about patronising it.
I do, however, think there’s a lot of scope for private provision of public services. This would allow government to fund services from public money (tax), but not provide them. It can select the most efficient provider, and companies can compete for the business. The obvious case for this is technical public goods — those that cannot easily be provided to some people but not to others, and whose use by one person does not significantly diminish their utility to others, such as sewerage, roads, etc. We can argue about what should fall under government in this way, but it would significantly improve the value proposition to taxpayers. But that’s a discussion for another day.
The point was, the UK Labour Party were wrong to nationalise Northern Rock. It sets a bad precedent, and will cause serious structural harm to the British economy.