New banks vs “good” banks

I’ve received a comment via email on my last post including the claim that:

“The good bank model does not necessarily interfere with the existing banks, it just creates a new bank and then allows a natural process of markets to take its course.”

I’d like to make it absolutely clear that I agree (moreorless) with the position of the correspondent who wrote this.

Maybe I wasn’t crystal, but I wrote last time that:

“There is nothing to stop new entrants offering loans in the UK.  The Government could even make it clear that they would be treated exactly like other banks in terms of receiving state support.”

The stronger position that governments actively establish banks (new, good, the remains of bad or whatever) and give them a competitive advantage is a no-no.  Even if there weren’t overseas banks operating in the UK, this would still be problematic (as in endless court cases, perception of political risk in the future), as it would undermine the interests of the remaining perfectly good UK banks.  Viable solutions have to observe the political (and moral) realities such as fairness of competition.

What I was dismissing were those expositions of the “good bank” model that involve interfering with the existing banks.  For example, the essay I’d internalised (i.e. I didn’t actually refer to it) was Willem Buiter’s “The Good Bank Solution” in the FT, which states:

“…the state would create one or more new ‘good’ banks – all state-owned and state-funded to begin with. … The good banks  would acquire the deposits and the good assets of the bad banks or legacy banks.  The good assets are, by definition, easy to value.  The creation of multiple good banks may be desirable to encourage competition.  One could even create a good bank for every existing bank: New Citi, New RBS, New ING etc.”

Not only does this obviously create unfair competition (as does hiving assets of a particular bank off into a “bad bank” leaving a good bank), and expropriate assets of existing shareholders*, it also, as I explained before, increases the risk to the public purse.

There is merit in the Government making it clear that new entrants into the banking market are welcome, even lowering barriers to entry, and offering such “new banks” at least some of the support facilities provided to the existing banks, on the same terms.

IMHO, governments are broadly following the right strategy, which I define as “muddling through” with a series of pragmatic measures.  Sure, they’ve made some wrong moves – my personal beef has been that they’ve done too little to encourage new private risk capital into the banks, in fact, with their bizarre attitude to Barclays in the UK (resentment that they didn’t take public money and outrageous threats from Alistair Darling that the Government deal would change if their own funding efforts fell through), they’ve moreorless discouraged it!  Purchasing (or insuring) bad assets transparently from all comers is a reasonably sensible next step.  And, as sustained deflation must be avoided at all costs (especially where there levels of debt secured against property), “quantitative easing” seems to be required.  Actually a sustained period of wage inflation (at the low end) is needed as this is preferable to property price deflation (because of the stagnating effect on the economy of negative equity), but more on that another time.

For media pundit economists to use their position to make propositions which fail to comply with the rules of the game (principally fair competition) is, to be frank, not very constructive.

I suggest proponents of more nuanced measures, such as my correspondent, distinguish their position from the “good bank” position.  Maybe they should call it the “new bank” position.

—-

* Oh yes, it does.  To pre-empt another blog post I’m thinking about, the point is we’re operating under conditions of uncertainty (though a lot of people behave as if they’re in some other kind of universe).  You might think banks are insolvent, but shareholders clearly do not (or the shares would be worth zero).  Reported bank positions are simply a matter of accounting position, and, as a wise fellow makes clear here, the true position won’t be known for “2 to 5 years”.  And he was just talking about individual assets – the “true” position of banks (or any other enterprise) is never a known quantity (unless they have zero velocity, to keep the particle physics/QM joke going!).

Buiter’s explanation puts no value on the continuing business of the bank – it’s simplistic to treat a business as if intangibles (its customer relationships, organisational capabilities and so on) have zero value.