It is impossible to be confident about the future development of market confidence. But the continuing mayhem in global equity markets and in most other systemically important financial markets, the fear and mistrust that have caused the banks to stop lending to each other and the growing sense of doom about the outlook for the real economy all suggest that without further radical policy measures we are unlikely to escape from the downward spiral sucking the world economy towards a re-run of the 1930s.
Lack of confidence in the viability of banks and other institutions with bank-like features, including high (embedded) leverage like AIG and other insurance companies is a key obstacle to a resumption of normal financial intermediation.
Action has been piecemeal and partial thus far. Some governments have taken controlling stakes in individual tottering institutions deemed systemically important. The Fed owns 79.9 percent of AIG and all of Fannie and Freddie. The governments of the Belgium, Luxembourg and France have taken significant stakes in individual tottering banks. The Dutch government is now the full owner of Fortis Nederland and of the Dutch rump of ABN-AMRO. The Irish government has guaranteed all bank liabilities, giving the tax payer plenty of downside risk without any upside risk. The UK government has introduced a voluntary scheme for recapitalising that may involve up to £50 bn of public funds injections, with the commitment that more will be forthcoming if necessary.
I believe that none of this may be enough and that the nationalisation of the banking sectors in the North Atlantic area is likely to be required if confidence is to be restored anytime soon. This majority ownership by the state of all systemically important banks and near-banks should be seen as a temporary measure, although certain institutions or classes of institutions may remain in state ownership for the indefinite future.
One problem with this nationalisation proposal is that governments with deep pockets are attached to nation states while many of the key banks have large border-crossing activities. That is why the original Fortis bailout (since undone), in which the Belgian, Dutch and Luxembourg governments each took a 49 percent stake in ‘their’ national bits of the Fortis Group was such a hopeful example. The fiscal burden sharing for the subsequent bailout of Dexia by the governments of Belgium, France and Luxembourg remains a model exercise.
The governments of the leading industrial countries with banks characterised by large border-crossing activities should immediately create international working parties to design fiscal sharing rules for these institutions. In the EU, an especially convenient model can be developed. There are about 44 large financial groups headquartered in some EU country but with signficant border-crossing activities within the EU. Each of these institutions could be re-incorporated under European Law as a European Company – Societas Europaea (SE). It is highly unlikely that an entity like the Fortis Group, for instance, would naturally be best partitioned into one bit that is 100 percent Belgian, another one that it 100 percent Dutch and a third that is 100 percent Luxembourguese.
As SEs, these European financial groups could come under full (or majority) state ownership without having to be partitioned along nation state lines. All of Fortis group could have become 45 percent Belgian, 45 percent Dutch and 10 percent Luxembourguese, say. Until the EU itself has independent budgetary powers, this is the best that can be done.