700 billion dollars, an expensive solution for the financial crisis

Confronted with the ample crisis of the financial-banking sector, the American government had to choose among three options: to do nothing for saving the banks, letting them by their own to find solutions, or to financially support them, but without taking over the control. The third option assumed that the American state to nationalize the banks that were in difficulty. The American authorities have chosen the second alternative, through the Paulson Plan of allocating 700 billion dollars for purchasing “toxic” banking assets (without liquidities).

Paulson plan is much disputed, being considered a fiscal burden difficult of being accepted by the American tax payers. The American government hasn’t involved in helping the banking system during the Big Crisis that hit the United States of America during 1929 - 1932, the results being already known. The valid alternatives remained the financial support or nationalization of the undercapitalized financial institutions. The Japanese government has also resorted to purchasing toxic assets for ending the banking system crisis from Japan that took place at the beginning of the ‘90s. The temporary nationalization was instead liked better by the Scandinavian governments during a banking system crisis similar to the one from USA which hit Sweden, Norway and Finland at the beginning of ‘90s.

When the banking system from a country steps into crisis it is necessary to be recapitalized for being avoided an excessive contraction of credit. The capitalization of the banking systems through using the public resources can take place in several ways: the government can purchase toxic assets (non-liquid), can infuse capital in preferential stocks or in common stocks, can purchase the debts of the institutions that face problems, can issue public bonds for covering the debts of banks. Moreover, there is the alternative that the financial institutions to benefit of the extended lines of governmental credit, or pure that the government to invest liquid money in the banking system. A recent study of the International Monetary Fund (IMF) which monitored 42 banking system crisis from all over the world, shows how various were solved the system problems which the banks have confronted in time. Firstly just in 32 of those 42 cases took place a financial intervention of any type from the involved governments. In those 32 cases in which the state interfered financially, just seven have included a program through which the governments have purchased assets/non-performing loans for supporting the banks, as stipulates the plan of 700 billion dollars of the USA Treasury. In 25 of those 32 cases the governments have chosen another type of intervention: in 10 cases they have purchased stocks (in six cases preferential stocks, and in other four cases common stocks), in 11 cases the state has purchased the debts of the banks, and in 12 cases has infused liquid money in the system. In two cases the banks have received credit lines, and in three cases the government has took over the passives of the institutions with problems.

Even when the state has purchased toxic assets, the shareholders of the banks with problems haven’t received the dividends that were suspended, so the profits and the recovered sums from turning to account the assets were used for covering the damages. There is also the situation in which the governments have chosen to use concomitantly several methods of banking recapitalization. So, purchasing banking assets by the government rather represented the exception from the rule. Just in states such as Mexico, Japan, Bolivia, the Czech Republic, Jamaica, Malaysia and Paraguay was used this method of banking capitalization. However, even in six of these cases, the purchase of toxic assets by the governments was combined with other forms of banking capitalization, such as purchasing preferential stocks or of the debts of the institutions with problems. Japan is the only country that has applied at the beginning of ‘90s, a recapitalization method similar to the one proposed by the USA Treasury, facing so with the highest costs derived from the measures for re-establishing the banking system taken by the government. Purchasing toxic banking assets proved to be the most expensive recapitalization method.

The plan of 700 billion dollars of the American authorities, through which the USA Treasury wants to recapitalize the financial institutions with problems by purchasing toxic assets, doesn’t derive from economical realities and has no justification, Nouriel Roubini, economy professor at the University from New York and president of the macro-economic on-line publication, RGE Monitor, states.

Purchasing, with public money, toxic assets that belong to the financial systems is a “robbery”, from which will benefit only the shareholders and the common creditors of the banks supported by the American state, Roubini sustains. He thinks that the recovery of the American financial system can be achieved through using more efficient the public money, because the plan of the USA Treasury only moves 700 billion dollars from the pocket of the tax payers in the one of the bankers and investors from Wall Street. The plan doesn’t respond to the need of capital of the undercapitalized financial institutions because it doesn’t force the shareholders and the creditors of the banks to use the capital received for recapitalization.

The American treasury would have used more efficiently the money of the tax payers if instead of purchasing toxic assets, it had infused public funds in the preferential stocks of the undercapitalized companies or it had completed the capital submitted to the risk (the capital of first rank) of these, not without suspending the dividends and asking to the shareholders to bring their own capital contribution. Moreover, a part of the uncovered debt of the bank must be converted into capital. All these measures would have directed to lower fiscal costs for the American government, because it would have forced the shareholders and the creditors of the undercapitalized banks to contribute to the recapitalization of the financial sector. The professor Nouriel Roubini sustains that the private sector would have contributed to the recapitalization of banks in equal measure with the funds allocated by the American Treasury, and would have been spent only 350 billion dollars from the public money, of which half were used for infusing public capital in the undercapitalized financial institutions and only 175 billion dollars were used for purchasing assets without liquidity.

The USA government supports with money the American financial system, receiving in exchange just a share from the capital of the financial institutions which sustains. In Sweden, the government has taken over the toxic assets of the banks, but has also taken over the control over the undercapitalized financial institutions, for being able to limit the damages that affected the state budged and the tax payers. Those 700 billion dollars represent 5% of USA’s GDP, a percentage comparable with those 4% from GDP in case of the Sweden crisis. But while the Sweden government has recovered at least half of the money, for protecting its citizens of the burden of supporting the damages derived from banks, the Americans have chosen to invest money in the financial system, the same as the Japanese, without taking control of the institutions affected by the toxic assets.

The Japanese have financed the bankrupt banks with generous loans, although many of these have paid even dividends to their shareholders. The Sweden banking system has recovered in about three years, the Scandinavian banks being at the moment regarded as of the most safety ones. Japan hasn’t recovered till the present, at more than 20 years from the crisis, several Japanese banks collapsing repeatedly under the burden of the toxic assets that they have in their portfolio.

The bankruptcy of a financial institution doesn’t mean its disappearance, Mark J. Perry, financing professor within the University from Michigan says. The bankruptcy assumes passing the ownership right of a bankrupt company from its shareholders towards its creditors. The bankruptcy penalizes the ones that have taken excessive risks and maintains in force those aspects of a business that remains profitable. In contrast, the governmental financial aid which a financial institution with problems receives, it transfers big volumes of capital from tax payers towards those who have assumed consciously the risks of granting risky credits (in case of the USA crisis - the subprime credits). So, the governmental financial support encourages the companies to have an imprudent behavior and to assume high risks, relying on the fact that they will receive public help. In this way, the “moral hazard” generates inequities in allocating the financial resources of an economy.