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Know losses before nationalization

Prem Sikka says it's time for a new strategy on bank bailouts

Vast amounts of public monies have been poured down the banking plughole. Credit markets are not working. The crisis is spreading. It is time for a different strategy.

The US government has already committed $8.5 trillion and an additional $800 billion is on its way. The exact cost of the UK bailouts is difficult to calculate, but the total of all cash injections, loans and guarantees are estimated to be around £900billion. Since 1997, UK banks are estimated to have paid around £50billion in tax, a tiny fraction of the bailout money. The government is bailing out not only the UK arms of banks, but also their global operations, including those in Caymans, Jersey, Bermuda, Liechtenstein and other tax havens which have been used to avoid taxes. The same banks also helped their clients to dodge taxes and thus narrowed the UK base, but are now being showered with money without any check on their tax dodging trade.

Despite vast armies of accountants and regulators the government have not told the people anything about the UK specific bank assets, liabilities, losses or exposure to toxic assets. Even banks do not seem to know the extent of their toxic assets. Bank of America acquired Merrill Lynch in a $50 billion deal, a price that considered toxic assets. It subsequently discovered that the toxic assets were much bigger than previously thought and itself had to be rescued by the US authorities in a $138 billion package. Earlier this year, Royal Bank of Scotland (RBS) unveiled a loss of nearly £28 billion. This was followed by HBOS, which announced a loss of nearly £11 billion. HBOS's lending increased between 2001 and 2007 from £125billion to £237billion. Yet it is silent on the proportion that might be toxic. Markets won't touch toxic assets or offer any insurance for such assets, but the UK government is willing to insure £400 billion of toxic debts. Experts believe that the taxpayer will pick up losses of over £100 billion.

  With each banking loss, calls for nationalisation grow louder. Yet it would be a folly to nationalise banks without knowing the losses that would need to be absorbed by UK taxpayers. Little is publicly known about the structure of bank assets, liabilities or exposure to credit default swaps - these are essentially bets that a company will default on its debt obligation. The market for credit default swaps is estimated to be around $55 trillion and the proportion that might end up with the taxpayer is unknown.

Sometimes to save a body, a cancerous limb needs to be sacrificed. The same may apply to banks. Government should save the retail and traditional side of banking and cut loose the investment or the speculative side which is primarily responsible for the current crisis. Yes, that would cause ripples, but there simply is not enough money to bail out the entire system. The rescued retail arms should be reconstituted as mutuals or co-operatives and forbidden from handling derivatives and ultra-risky products.

The newly constituted banks should be under the control of depositors, borrowers and workers. That is a far cry from the government policy which makes no distinction between the commercial and speculative activities and wants to promote more of the same. Chancellor Alistair Darling told the G7 summit, "I've made it very, very clear on a number of occasions that we believe that banks are best run in the commercial sector and privately owned, properly regulated and supervised. That's the best place for them to be and our policy hasn't changed one bit".

Democratisation of the banking system is the key to future stability and curbing reckless risk undertaking by executives. It also simplifies regulation as the speculative side of finance needs regulation which is qualitatively different and more stringent from the traditional banking side. Stock market pressures for ever higher returns encouraged banks to constantly develop new financial products, with disastrous results. Yet government is proposing more of the same. Despite pouring billions of pounds, the Government has not even taken statutory powers to appoint bank directors. Instead, they only have powers to appoint non-executive directors, who are part-time and toothless and have already failed.

Governments continue to believe that banks are engines of economic growth. Other ways of supporting society have been ignored. For example, instead of pouring £900 billion into banks, government could have provided money to each distressed household. People could have chosen to repay their bank debts and thus reduce the amount of toxic debts and at the same time provide liquidity to the banking system. £900 billion could have created lots of infrastructure, reduced imported energy dependency and encouraged green industries. However, such policies have not been considered. Indeed, little is known about the options that the government has considered and evaluated.