Saving banks is part of the problem, not the solution

With the real world economy racking up ever more startling numbers in terms of stock market lows, GDP contraction, unemployment and government deficits, one has to wonder: are governments focusing on fighting the right fires?

The catalyst for the question is the remarkable comment by German chancellor Angela Merkel, reported on March 12, about bailing out car maker Opel. According to the Associated Press, Merkel stated that the government should only bail out companies 'with a future'. Opel is currently owned by General Motors, but the German unit is looking at ways to regain its freedom, which is why it's seeking government support. Given that Opel is asking for a measly $4.2 billion in state help, while the government has already injected $104 billion into the German banking sector (recent developments suggest this could double to over $200 billion), the government's priorities seem pretty clear -- despite the 50,000 Opel jobs at stake.

If we tot up how much money is involved in the banking meltdown, the brain has difficulty taking it all in. To take one example, freshly nationalised Royal Bank of Scotland's balance sheet is just under $3 trillion, which is bigger than the UK's GDP of $2.1 trillion. Yet despite the huge cost of bailing out such an entity, the expenditure has not prevented a collapse in the UK's GDP, predicted to shrink by 3% in 2009.  

Help for the wider economy has been less forthcoming: the UK stimulus package is 'just' $250 billion, less than 10% of the RBS balance sheet. The German stimulus package amounts to $64 billion, compared to the $100 billion the government has spent on the banking sector alone, and for a larger GDP ($3 trillion) than the UK. The total US stimulus package amounts to around $800 billion. Sounds big -- but the revised rescue package for AIG now amounts to $162 billion, or over 20% of the stimulus plan.

Saving the banks was theoretically done to prevent a systemic breakdown, not for any other reason. Let's pedantically remind ourselves what a systemic meltdown is: it's a meltdown that threatens when a problem can't be localised and becomes so great that it brings down the whole system. This danger invariably arises during a banking crisis. In the old days, there would have been a run on deposits, wrecking the bank's essential ability to push money around the system. Today, we are seeing the same fear of a credit crunch, but it is caused by bank losses eroding lending ability -- hence the gold-plated bailouts.

Yet, despite the mountains of treasure that has been vaporised in trying to fix things, this systemic failure is happening anyway. Banks are building up their capital ratios and balance sheets instead of lending, while, just as importantly, companies are not borrowing for fear of the future. So why is all that money being spent on banks? We are going to have to pay higher taxes tomorrow to fix today's budget deficits. If governments choose to inflate their debt away, our savings and income will suffer. If the price to fix the banks is either a massive tax burden or a degraded currency and the economy goes down the pan anyway, what's the point?

So maybe it's time to bail out the real economy with the same firepower (or what's left of it) that has been lavished on the banks -- after all, the real economy is where most people live. If governments could save the real economy by extending cash infusions to companies and individuals and renewing confidence, the banks should eventually recover as well. Such a bailout might look a bit like socialism or nationalisation, but it would be somewhat hypocritical to complain about that, given how much money the supposedly free-market kings of finance have already received from the taxpayer.