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Long live conservative banks and conservative policies

March 7th, 2009 · No Comments

More and more evidence that countries which have a tight grip on their financial system have fared better, much better, in the present crisis..

Long live conservative banks and financial policies!

We give the gist of a really excellent article (which is in Dutch, we’re afraid) by a professor of economic history (Jan Luiten van Zanden, if you must know):

  • Banks survived the past crisis (1975-83) quite well, basically because the regulation environment was completely different they weren’t involved in excessive risk taking, and had hidden reserves
  • Deregulation changed this, the hidden reserves were one of the first victims
  • Valuations were ever more market based (instead of based on historic cost) and markets for all kind of new financial products themselves expanded enormously. This development, and increased transparency has made banks (and pension funds) much more vulnerable to the business cycle
  • So when times are good, balance sheets are rapidly expanding and increasing in value, credit is easy, feeding on one another and the business cycle is reinforced
  • When things are bad, exactly the reverse happens, balance sheets shrink and decline in value, credit is restricted and assets are sold in fire sales
  • These mechanisms are reinforced because so many banks themselves are now listed on stock exchanges, inflating their price in good times, and deflating them in bad times. This has put two turbos on the above pro-cyclical mechanisms
  • One through incentives, management bonuses are often a function of the stock price (or at least related to these), leading to excessive risk taking (and even gaming).
  • In bad times bank stocks themselves fold, reinforcing the downward spiral set out above.
  • It’s no accident that the erstwhile UK building societies, which used to be cooperatives, were among the first victims after they went public
  • The whole financial sector has no been supercharged, limited disturbances in their environment can lead to enormous changes in their profitability and solvability, setting of self-reinforcing loops that reinforce the business cycle.

And we have to add that the author hasn’t even included the use of outlandish leverage and the ‘shadow banking system’, that unregulated part of investment banks, private equity funds, hedge funds, etc. where leverage and risk taking was most pronounced.

The conclusion of the author: take the banks of the stock exchange and nationalize them temporarily. No surprise there.. Some other examples:

  • China’s state banks are expanding credit at record pace, slumping exports (which are some 40% of GDP, far bigger than for the EU or the US) notwithstanding
  • Brazil’s regulated banks have only been scratched at the surface in the crisis (see below)
  • It’s no coincidence either that a large cooperative bank like Rabobank of the Netherlands announced record profits for 2008, compare that with those UK building societies that went public, like Northern Rock

Here is what The Economist had to say about Brazil:

  • ANY list of the things that hold back Brazil’s economy would until recently have included overbearing state influence in the financial sector. The government controls Banco do Brasil, a huge retail bank, and Caixa Econômica, the largest mortgage lender, plus the BNDES, a big development bank that feeds cheap credit to favoured companies. Hugely expensive bank loans are a handicap, too. And yet under changed circumstances such lamentable policies suddenly look far-sighted, and have given the global downturn an unusual tinge in Brazil.
  • Other countries are trying to work out how to run banks and direct credit to where politicians think it is needed. This is something Brazil did even when it was unfashionable. It is a sign of the times that a recent research note on Brazil from Goldman Sachs listed state involvement in banking as a plus. As for the private banks, the huge reserve requirements and taxes on funding that push up the price of their loans discouraged them from the wild risks that have brought down some peers in Europe and America. So far, credit in Brazil has been lightly chewed, not crunched.

Tags: Credit Crisis · Public Policy