Karl Marx's Revenge

Today has seen what is effectively the partial nationalisation of the financial sector in the UK, but also in the US.

To start with the UK, although it is not strictly speaking chronologically correct to do so, Her Majesty's Government is reportedly contemplating buying a £50 billion stake in British banks (BBC). Apparently it will follow the Buffett model of getting very preferential shares and warrants for common equity.

Ben Bernanke seems to have come up with something slightly different. He is proposing that the Federal Reserve will buy commercial paper from cash strapped firms directly (transcript on the Washington Post). To finance this without printing dollar bills, or Treasury bonds which in the short term amounts to much the same, he is proposing to take advantage of new powers to pay interest on deposits - and thus encourage those them to write off assets. You can't dofirms with spare cash to deposit it risk-free. In other words, he is going to be running a bank. Rather than buy equity in the banking sector, which is politically unpalatable in the States, he is going into competition with banks, who are in no position to compete.

Of the two schemes, I prefer the US one. Rather than effect a partial nationalisation of the whole banking sector, Dr Bernanke is proposing what is effectively a total nationalisation (albeit with a time limit, unfortunately) of the money markets. The benefits of having private money markets have always seemed marginal. In normal markets they are very closely correlated to policy rates anyway. When they deviate from policy rates (like now) it is cause for alarm rather than a celebration of the efficacy of the market. And it is an area that is too vital to the economy to abandon to the markets. By nationalising the money markets, the Fed is removing a level of indirection from its policy rate-setting and does not make a vast contribution to capital efficiency anyway.

Alistair Darling's scheme, on the other hand, invests taxpayers' money in a failing industry. I've been consistently making the point that the banks are not principally under-capitalised so much as over-leveraged. Yes, an injection of capital will allow their balance sheets the flexibility to write off junk assets without bankruptcy. But what does this actually mean? It means that they have debts which their assets don't cover. It means that they need someone to give them equity capital to pay off those debts. Then they can write down those assets. It effectively means HM Treasury is paying off their debts, and, by way of a sweetener, receiving equity a fraction of the value of the money they have actually invested. Politically palatable but hardly a sound investment.

Of course, the Fed won't actually be allowed to undercut the banks and drive them out of business. That just isn't politically tenable in capitalist America. But that's a pity because it's the closest we've seen to the right solution.