Over a century ago, Americans had great admiration for many things British, including the British skill in finance. Before World War I, London served as the center of international banking, borrowing money from some countries at one rate of interest and lending it out to others at a higher rate. In a celebrated paper read to the 1901 Milwaukee meeting of the American Bankers Association, A. B. Stickney, president of the Chicago Great Western Railroad Company, eulogized Britains achievement:
England has so organized her capital by means of her magnificent banking system that she is the banker of the world, and collects tribute from all the nations of the world in the form of interest, not for the use of her wealth or capital, but for the use of her credit. Paradoxical as it may sound, it is literally true that by means of her splendid banking organization England collects interest upon millions and millions of her own indebtedness to other nations.
Even two years ago, London could claim, without obvious exaggeration, to be the worlds leading center for international finance. Its leadership stemmed partly from its highly cosmopolitan character: banks from all nations came to London to compete in various endeavors of capital-raising. But the intensity of the foreign competition did not mean that Britain had no champions of its own. Such organizations as HSBC, the Royal Bank of Scotland, and Barclays held significant market share in a wide range of financial activities, from foreign exchange trading to bond underwriting to household insurance. They were well regarded by their peers, and in the first half of 2007 they were profitable, well capitalized, and fully regulated.
Today, thanks to the banking crisis and government mismanagement and overreaction, the situation is utterly different. The banking crisis has shown that these businesses became too heavily dependent on so-called wholesale fundingfunding available from other banks and large official institutions all over the world. When that spigot turned off in August 2007, the volume of new lending dropped sharply. Stock markets and industrial output began falling and have continued to fall more or less ever since. The banks have had to write off bad debts, and in some cases have reported large overall losses, as asset write-downs exceeded their operating profits.
Still, banks audited reports indicate that their capital continues to amount to tens of billions of pounds. Indeed, the whole British banking system has nearly $400 billion in capital. But politicians love a crisis, and Britains politicians have proceeded to make the crisis immeasurably worse. Leading parliamentarians and commentatorsincluding such prominent figures as Vincent Cable, deputy leader of the Liberal Democrats, and John McFall, chairman of the Treasury Select Committeeclaim that the banks have gone bust and that it might be time to nationalize the entire banking system. This amounts to asserting that $400 billion has somehow vanished into a financial black hole.
Unlike the United States, Britain does not have a written constitution with Fifth and Fourteenth Amendments prohibiting the state from seizing property without compensation. But Britain is a civilized society under the rule of a law that defends property rights, isnt it? If the government nationalizes a company, precedent says that it must compensate shareholders. According to most legal precedent in the European Union, book value provides the proper basis for such compensation. One can debate, of course, the precise definition of book value for Britains banks, but a fair guess is that it amounts to the capital they hold. In other words, if the British government wants to nationalize the banking system, it would have to pay shareholders about $400 billion.
If the banks are bust brigade has its way, however, that figure will be zero. Consider what happened in 2008, when the government did nationalize two banksNorthern Rock and Bradford & Bingleyand passed legislation designed to ensure that shareholders received next to nothing in compensation, though both banks had substantial book value when they were forced into public ownership (unlike American firms like IndyMac and AIG, which were insolvent when they became government concerns). The government justified its action by arguing that the two banks, which had encountered difficulty financing their assets because of the breakdown of the international wholesale funding market, had become dependent on loans from the state to stay in business. Given such dependency, the reasoning went, why shouldnt the state be entitled to strip shareholders of everything? In recent months, the same argument has been advanced regarding Britains former international champions, including the Royal Bank of Scotland and Barclaysbusinesses with assets running into the trillions of dollars.
If the British government goes further down this road, the American Bankers Association will never again cast admiring glances at Londons ability to earn interest on the money it owes. The dissolution of Britains banking industry under Gordon Browns premiership bears comparison with the dissolution of the monasteries under King Henry VIII. One could argue that, rather than nationalizing assets, the British state has been expropriating them.
Tim Congdon is one of the United Kingdoms leading economic commentators.