World - Not through ideology

You wouldn’t have thought that an ex-chairman of Goldman Sachs would be ordering what someone has called “the greatest nationalisation in the history of humanity”. But that is what Hank Paulson did last week-end when, as the US treasury secretary, he nationalised the giant mortgage refinance companies, Fannie Mae and Freddie Mac. That immediately cost the American taxpayer $200 billion, and doubled the US public debt by adding $6 trillion to the total. This is only the latest in a long sequence of events where governments in different western capitals have stepped in to take over or salvage banks and other financial institutions. In February, there was the British nationalisation of Northern Rock (which added about $100 billion to government loans and guarantees); in March, the Fed-facilitated takeover by JP Morgan of Bear Stearns; and in April, the German Bundesbank’s $7 billion bail-out of WestLB.

Meanwhile, the Abu Dhabi Investment Authority now owns 5 per cent of Citigroup, becoming its second largest shareholder after it pumped in $7.5 billion; Temasek, a creation of the Singapore government, owns 17 per cent of Standard Chartered, while the Government of Singapore Investment Corporation picked up a 9 per cent stake in UBS (at the same time as an unnamed West Asian investor also stepped in) when that large Swiss bank needed fresh capital. Finally, earlier this week, Lehman Brothers decided to dismember itself only after the state-run Korean Development Bank decided not to put money into the troubled New York firm. Through all this, private investors in financial firms have been losing their shirt, as one bank or investment firm after the other has acknowledged massive writedowns and/or incurred unprecedented losses. Citigroup, for instance, has lost 60 per cent of its market value, others have done even worse, and the blood-letting still continues. The result is that many of the storied New York firms are now worth less than some Indian banks!
What is the moral of this story? Martin Wolf declared in the Financial Times on Wednesday that “the US government … (should) spare us homilies on the sacred role of free financial markets for a long while”. Certainly, people in Asia and South America will remember the advice given by Washington when there were financial crises in these regions — nationalisation was never a part of the package. But if free-flowing financial capitalism is now discredited in most people’s eyes, because profits stay in private pockets while losses become part of the public debt, that is still not the predominant view within the global financial community — which does not accept that its model is broken. One consequence is that the search for a new financial sector paradigm has barely begun.
All this is of immediate relevance in India, when a new governor has taken charge at the Reserve Bank and faces the challenge of structurally reforming India’s financial sector. There is pressure to open up more to international banks, the government-owned banks need to be brought up to speed in many ways, and financial inclusion remains a challenge. It is vital at this stage to not view issues through an ideological prism, and to focus on what works. For instance, the Cornell economist Kaushik Basu has argued recently that one reason for the acceleration of Indian economic growth in 1980 (from 3.5 per cent till then to nearly 6 per cent) was the much-reviled bank nationalisation of 1969. This resulted in the spread of bank branches into small towns and the countryside, and helped increase the extent of financial savings, which helped finance higher growth. Talk of the law of unintended consequences! So it might be that, in terms of relative importance, measures to further improve financial inclusiveness are more important than the more fashionable talking points of bankers.