24 February 2017

The state should never have bailed out RBS


RBS has reported a loss of £7 billion for 2016. That is its ninth straight year of losses, taking its total cumulative loss over the period to more than £58 billion, more than the £45.5 billion the government injected into it in the 2008 and 2009 bailouts.

The government’s stake in RBS was acquired for the equivalent of about 500p per share. At the time, many politicians and financial commentators claimed that there was a market failure in the pricing of bank shares and hence the valuing of bank capital.

Indeed, this alleged market failure was one key justification for bailing out the banks. Since the market was valuing the banks irrationally low, it would not be economically efficient to allow the natural market and regulatory response to that low valuation — the bank’s creditors (in particular bondholders) having the debt they owned converted into equity so that they then owned the banks, recapitalising them.

To allow that to happen when the market was failing to get the value of banks right would create unnecessary transitional costs for society as a whole.

Well, that argument was right on one point: 2008/09 the market was getting the value of RBS wrong. Even after £45.5 billion was injected into it by the government and even after nine years have passed, its value this morning was less than 250p per share, or less than half that when the government bought it. In 2008/09 the market considerably over-valued RBS.

Does anyone believe that, if RBS had fallen into the hands of its bondholders in 2008/09, and been forced to restructure by owners with a commercial interest in making it a value-generating enterprise and under pressure from competitors that would sweep up its customers if it didn’t sort itself out quickly, it would still be making losses nine years later?

It’s obviously true that RBS has had significant changes in management, and has attempted to restructure all kinds of parts of its business. But at the end of the day, it’s had a large chunk of its shares owned by the government. In capitalist economies, shareholders are not simply a passive spare part. The need to provide dividends and capital growth for them forces businesses to be efficient and innovative and to maintain a reputation and manage risk and all kinds of other important economic tasks.

If those shareholders are the government and they don’t care if the company makes a profit, companies will act very differently. Governments do not make good owners of banks any more than in the past they made good owners of restaurants, phone companies or car manufacturers.

So the claim that the government was justified in taking over RBS because of some market failure, and that its doing so would enhance economic efficiency, can be seen with the benefit of hindsight to be as bogus as it obviously was at the time.

Another set of recent events that shines a light upon the bank bailouts has rather slipped under the radar. One of the other big claims about the bank bailouts was that they were necessary in order to avoid economic disaster. The chutzpah of the self-interest of that claim somehow passed most comment by at the time.

From the mid-1970s to 1990s economists told us that when shipbuilders, car companies, steel works, coal mines and the like shut down, that was necessary for economic efficiency, even when it resulted in systemic damage to whole regions, with other connected firms and industries shutting down across large parts of the North-East, South Wales, Scotland and the Midlands and unemployment elevated for decades.

In those cases, that was the market, and in the long-term the economy and society as a whole would benefit. Quite so – they were right then.

But in 2008, it wasn’t folk with regional accents in dirty overalls and young people’s future employment hopes that would be affected, far away from the Metropolis. Instead, London bankers in suits and rich elderly depositors in failed banks were the ones who might lose money. Suddenly, the economists who — by a total coincidence — worked for the banks concerned, miraculously discovered that systemic risk was impossible for society to tolerate and allowing market forces to work would be an economic and social catastrophe.

Well, as we know, this nakedly self-interested tale carried the day. Did bailing out the banks avoid a huge recession? No. In the UK we had the worst recession since the 1920s. In Spain and Greece unemployment went above 25 per cent and the West has seen its first sovereign default in generations. The bank bailouts failed that economic test.

“Ah, folk tell me, but if we’d not bailed out the banks, things would have been even worse!” Says who? Some economists. Not orthodox economic theory — as so often, it’s economists not economics saying these things.

So lots of economists, particularly of banks with a vested stake in what policy is adopted, told us that if we didn’t go with their preferred policy there would be immediate economic disaster. Does something about that sound familiar?

Is there any situation we might point to where we didn’t go with what the conflict-of-interest doomsaying bank economists told us we had to do, so we can get a view on whether they might be right in such cases? Ah yes: we voted to leave the EU.

One key implication of the performance of the economy since the Brexit vote seems to me to be that folk should abandon whatever residual credibility they were giving to the claims of bank-employed economists about how terrible it would have been if the banks hadn’t been bailed out in 2008 and 2009.

Bailing out the banks has not been justified by subsequent events which showed that markets were significantly under-valuing them at the time. And subsequent events do not suggest we should have placed great faith in the claims of bank economists about how bad the economic effects of not bailing out those banks would have been.

Here’s the key lesson: next time (and there will be a next time), listen to the lessons of economics, not the doom-saying of conflicted economists.

Andrew Lilico is an economist and political writer