Heading for a Europe-wide government guarantee: how do we ensure legitimacy?
Since my post below, I see Angela Merkel has provided an explicy guarantee of 100% of deposits in German banks and word is the Westminster Parliament will be presented with a similar proposal next week. When governments have to guarantee the deposits of the entire banking system as the price of freeing up lending both between banks and to companies and households, we might as well admit we have a failure of the banking system.
Whatever the precise legal rights and liabilities for different parties, the fact is that only the taxpayers have the ability, through the agency of government, to keep money flowing through the economy, and even that may be a highly inefficient flow. With taxpayer control we also see the effective failure of the structures of bank supervision and monetary policy. This had already virtually happened in the UK, with the Bank of England having a fraction of the balance sheet required to fill the breach of some £200 billion of wholesale funds, roughly a third of the total, that the banking system relies on in addition to direct deposits. Most of the rest looks at the moment like it has a snowball’s chance in hell of being rolled over. With the taxpayer underwriting open-ended expansion of the central bank’s balance sheet, its independence, including over monetary policy, goes out the window. So do the supervisory powers of the FSA and international accounting bodies. But these are structures that can be adapted to the new realities in time rather than in haste.
While all eyes for the last two weeks were on America’s struggle, at times tawdry and at others noble, to achieve some political legitimacy for government stepping in to deal with a market failure, this week we should see a similar fundamental debate over what terms UK and other European taxpayers should expect for acting as the agent of the state’s momentous new intervention in the economy. The terms that confer legitimacy must involve equity. Free-market proponents are the ones who should lead that charge. One means might be to legislate both for higher capital ratios and the combination of dividend cuts and access to new taxpayer equity on tough terms to meet these new standards. Good banks will be diluted less than bad banks but all banks’ shareholders, both small and institutional, will be given a lesson in capital stewardship which they might actually remember.