Tuesday, 7 October 2008

It is up to RBS, Lloyd's TSB, and Barclay's shareholders to take risk - not the taxpayer

The BBC reports this morning that Royal Bank of Scotland (RBS), Lloyds TSB, and Barclay's have approached the government for injections of taxpayers money into their shares http. The answer should be a firm 'no'. And the reason the answer should be 'no' takes us to the core of the present financial situation.
Free markets are supposed to operate by entrepreneurs bearing the consequences of both success and risk: if they take the right decisions they profit, if they take the wrong decisions they lose. When the companies made profits shareholders took returns, and when they suffer losses that is equally their responsibility.
Market economics will be perfectly aligned with voters opinions. While individual savers' deposits should be safeguarded there should not be a safeguard for shareholders - who benefitted when the companies profited, and share prices rose, and who should not be protected from downside risk by tax payers.
It is being said that what was reported to be proposed by RBS, Lloyd's TSB, and Barclay's was an example of the way Sweden deal with its bank crisis in the 1990s. This is completely false. As the former head of the Swedish central bank pointed out, in Sweden: ‘The bank guarantee provided protection from losses for all creditors except shareholders.’ The reason for this is that it was necessary to ‘enforce the principle that losses were to be covered in the first place with the capital provided by shareholders.’
As Urban Backstrom, a senior Swedish Finance Ministry official at the time, put it: "The public will not support a plan," he said, "if you leave the former shareholders with anything."’
Or as the US International Herald Tribune stated: ‘Sweden did not just bail out its financial institutions by having the government take over the bad debts. It also clawed its way back by pugnaciously extracting equity from bank shareholders before the state started writing checks.'
It may be said that such large banks 'cannot be allowed to fail'. But this is to confuse two quite separate questions. Certainly the deposits of individual savers in the banks should be safeguarded, and this can be done by the state, that is the taxpayer. It may be necessary to take banks into public ownership and ensure they function as occurred with Northern Rock and Bradford and Bingley - and it is notable that Northern Rock is now one of the safest banks in the country actually turning away depositors. But the shareholders equity should not be guaranteed - they took the profit and they take the loss. Taxpayers should not be bearing the risk of wrong decisions taken by shareholders.
It is said that there is an upside for taxpayers if they take shareholding in these banks. But there is also a downside - and that is a much greater risk in the present situation. Most sovereign wealth funds of individual countries that have taken positions in financial institutions in the last period have lost huge sums of money.
In any case the downside risk of taking a shareholding position can be entirely eliminated for taxpayers and taxpayer value maintained. If the value of shares in the private companies goes down to zero when they are taken over then the taxpayer cannot lose money on that particular transaction. If any price is paid then the taxpayer has a downside risk.
If ordinary individuals wish to invest in the shares of RBS, Lloyd's TSB, and Barclay's that is entirely their right. But the government has no right to compulsorily force people to invest in these banks by using taxpayers money to buy their shares. And it will become drastically unpopular, and risk huge financial losses, if it does so.
The government has regained popularity by its firm position on Northern Rock and Bradford and Bingley. It must not lose it by taking risks with taxpayers money that should be borne by private shareholders.

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