Public banks and misplaced priorities

State-owned banks simply do not allocate capital to the most efficient and profitable enterprises

Fannie Mae and Freddie Mac are United States government-sponsored mortgage firms. Often seen as the originators of the subprime mortgage crisis in the US, these two quasi-governmental organisations need more money. They have requested an additional $1.8 billion from the US government, which brings the total to $148.3 billion since the financial crisis began.
 
How did a staid, quiet, boring government-related financial institution get into this mess? The answer is simple. Government banks simply don't work. The economic purpose of banks in a market economy is to help investors or depositors allocate capital to the most efficient and profitable enterprises. In a recession, their job is to eliminate as quickly as possible inefficient or failed businesses for the least amount of loss.
 
State-owned banks and other state financial institutions simply cannot do this. It is bad enough that politicians allow public funds to follow political power. It is far worse that politicians force banks to allocate depositor money to the politically connected rather than the financially successful.

The problem is not just in the US. It is everywhere. There is hardly a country where a state-owned bank either has or will create a financial crisis. It is not a question of culture or the ability of a legal system to regulate the financial industry.

Politicians are the legal system. They make the laws. They create the regulations. They control the regulators. If they want public or depositor money to go to a particular segment of the economy, it goes to that segment regardless of its economic potential.

Fannie and Freddie were able to bend the rules because of their close relationship with Congress. The extent of their interrelationships was exposed as far back as 2007 when they were fined a record $3.8 million for using corporate resources to support the campaigns of 85 members of Congress. The fine did not even slow their path to ruin and political clout insured no supervision.

One would think that the tidy Germans could manage to sustain strong banks, but the system of Landesbanken, independent state banks jointly owned by the state governments and the savings banks, have been a constant sore. As far back as 1987 they set up a 'bad bank' to deal with troubled loans. They went through major restructuring in 2002 and 2005 attempting to get rid of billions of euros in bad loans. Protected by state guarantees they happily gobbled up subprime mortgage products and created off-balance sheet vehicles. Of course two of the Landesbanken were among the few banks to fail the recent European stress tests and others refused to disclose details.

It is not just the developed countries. In Brazil, the country's state-owned development bank, BNDES, has been called "the best bank in the world". The reality is quite different. Like China, Brazil's government used the public banks to pump money into the Brazilian economy. In 2009 private bank lending grew only 10% while loans from public banks rose by 50% and most of that was from BNDES. Like China the loans from BNDES do not go to efficient smaller enterprises, who hire the most people. Instead they go to the largest and
best-connected firms. Four-fifths of its loans go to large companies. Often these are state-owned firms like Brazil's oil giant Petrobras. BNDES is subsidised, which makes it difficult for private banks to compete. Considering the amount of new lending and the potential for political interference, there is no doubt that bad debts will mount.

Finally the worst of the worst is China. We discovered recently that Wall Street is not the only place that specialises in off-balance sheet securitised loans. Last year Chinese state-owned banks lent an incredible 9.6 trillion yuan ($1.4 trillion). The Chinese are trying to slow the lending down. Their target for 2010 is 'only' 7.5 trillion ($1.1 trillion). The estimate of lending in the first half of the year is $4.6 trillion yuan ($680 billion).

Under the regulations lending by Chinese banks is limited to their capital ratios. But the banks found a way around the regulations. Like banks on Wall Street, Chinese banks securitised the loans and sold them to Chinese trust companies and so removed the loans from their books and from the credit ratios. The result is that the level of Chinese loans for 2010 is 1.3 trillion yuan ($192 billion) higher than realised.

The extra money not only exacerbated the real-estate bubble and inflation, but will no doubt lead to a massive amount of new bad loans. Worse, in order to avoid inflation, the Chinese authorities may have to try harder to tighten an out-of-control money supply. Whatever the reaction, the result will not be pretty. Also like Wall Street, China's financial problems will not stay at home.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected]).
 

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COMMENTS

Narendra Doshi

6 years ago

How about your giving Moneylife readers similar facts from India, in the not too distant future??

3G rollout to increase mobile internet providers

Kolkata: The roll-out of much-awaited third generation (3G) services by mobile service providers will lead to increase in the number of Internet Telephony Service Providers and sharp reduction in International Long Distance (ILD) call rates due to mobile voice over internet protocol (VOIP) service, reports PTI quoting a top official of a VOIP company.

"Mobile phone customers with 3G subscriptions will be able to replace high cost ILD calls by making VOIP calls for as little as one-tenth to one-eighth of the cost with the introduction of the mobile VOIP applications by ITSP," said Sanjit Chatterjee, director global marketing and strategy, Reve Systems of Singapore.

To make cheap ILD calls over mobile VOIP, all a mobile phone user has to do is download the 100 kb application iTel mobile dialler developed by Reve Systems, the global pioneer in VOIP, says Mr Chatterjee.

A typical voice call from an Indian mobile user’s phone can be made by dialling out a mobile or a fixed line number from the mobile phone book using Reve’s mobile Dialler.

The call travels over the data line of mobile service provider or Wi-Fi network and terminates at caller’s desired phone using last mile connectivity of his service provider, say an AT&T in the USA or an Orange in Europe.

An ILD call to say a country like the USA would normally cost Rs8-Rs10 per minute can now be made using a Mobile VoIP service at just Re1 per minute or lower, he claimed.

Mr Chatterjee claimed Reve has a customer base of 1200-plus ISPs in over 50 countries where 3G services are being offered currently and the 100 KB iTel Mobile Dialler has been downloaded in over 30 million mobile phones in 50 countries of the world.

Mobile VoIP is gaining ground globally, he claimed and said in October, 2009 AT&T in the US allowed its iPhone users to use iPhone VoIP application on its 3G network, responding to surging customer demand (earlier, iPhone users on AT&T network could use the mobile VoIP application only through Wi-Fi connectivity).

"Reve’s mobile VoIP dialler is versatile, has easy user interface and built in tunnelling capability," he added.

Reve’s iTel Mobile Dialler Express, is the category leader in Mobile VoIP, enables service providers to offer seamless Mobile VoIP experience to end users. iTel Mobile Dialler was named product of the year by Internet Telephony magazine in 2009.

Reve is also a member of Symbian Foundation and part of iPhone, BlackBerry developer community. The company is headquartered in Singapore with offices in Bangladesh, India and the UK.

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Inflation rate to decline at 9.6% in Q2 FY 11: CMIE

Mumbai: Latest forecasts promise good news on the inflation front. India's wholesale price index (WPI) based inflation is projected to come down to 9.6% in the second quarter ending September 2010, reports PTI quoting the Centre for Monitoring Indian Economy (CMIE) in its monthly review.

WPI inflation in the June 2010 quarter was 10.6% as compared to barely 0.5% in the same period a year ago.

The decline is projected to continue in the subsequent two quarters too, to 8.1% and 6.5% in the quarter ending December 2010 and March 2011, respectively, CMIE said.

The decline will be partly brought about by a high base in the second-half of the preceding fiscal year. The other factors that are expected to keep inflation down include an expected surge in the 2010 kharif crop production and an increase in sugar output.

The Reserve Bank of India's (RBI) response to rein in the higher inflation has intensified in recent months. On 27th July, RBI hiked the repo and reverse repo rates by 0.25 and 0.5 percentage points, respectively, to 5.75% and 4.5%. This was the fourth hike in the current calendar year.

The most important objective of the hike according to the Reserve Bank was to moderate inflation by reining-in demand pressure and inflationary expectations.

The wholesale price index (WPI) based inflation is expected to be at 8.5% in FY11 as compared to 3.7% in FY10.

"We expect WPI based inflation to be 8.5% in FY11 as compared to 3.7% in FY10," CMIE said.

Of the three segments, inflation in the fuel group is projected higher at 10.3% in FY11 as against -2.4% recorded in FY10. Likewise, inflation in manufactured goods is projected to remain higher at 6.4% in FY11 as compared to 3.2% in FY10, the CMIE report said.

The current higher inflation originated from the supply-side on account of a decline in agricultural production in 2009-10 and increasing international commodity prices. Food item as a major source of inflation in FY10 has been replaced by fuel, textiles and metals in FY11.

In addition, higher inflation continued in commodities like milk, eggs, fish and meat. Administered prices of coal, sugarcane, iron ore, petroleum products, electricity and fertilisers have also been revised upwards between December 2009 and June 2010.

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