Bank Bailout, where fear of nationalization by Obama administration is looming large in US and debate is on pro and cons, it looks Government is running out if ideas or have enough of ideas which are not producing results. Even though the government is helping banks, it looks much money is going to “Men in Ties” for all bonuses and their good work last year ( well the logic is, performance is relative and they did their best job in reducing over all losses in a difficult year !!) What ever the case, my take is Obama can try taking a different approach and can try using Divide and Conquer Strategy to tackle the crisis created by “Men in Ties”
Why do we need Bailout of Banks? Banks (or Men in Ties) took huge business risk and suffered, so why their businesses need to be bailed out with public money? Well the answer is if the banks go burst, they will cause suffering to public especially millions of small investors. The current problems in banking industry are because of the structure of this industry.
On risk of being over simplistic, Banks functions can be classified into three buckets:
* Generating Funds by channelizing deposits from public ,
* Distributing Funds to the public in form of loans and other investment vehicles (Here “Men in Ties” are most active!!)
* Transmitting Funds and keeping the financial systems working by providing short term liquidity, funds to various entities.
In the current banking industry structure, big banks provide all the three functions and are the ones which need desperate government help.
How can these problems be fixed? Well structure of utility industry may give ideas.
Take analogy from structure of utility industry where three functions Generation, Transmission and Distribution of power are separate and managed by separate entities. Similarly banks functions are like Generation, Transmission and Distribution of funds. These three functions can be separated into different entities. This division can help in narrowing down the present and future problem areas under different entities. Then government can nationalize or utilize other tools to solve these problem entities.
There can be three types of banks:
* Generating Banks: Which can channelize generation of funds by taking deposits from public. There is no problem in this system and banks are doing much better than government. ( Here “Men in Ties” are not that active and mostly marketing and efficiency is required)
* Distributing Banks: Which can distribute the funds to public for loans and as investment options. This is the problem area, where banks have taken reckless risks which in turn started problems. Here “Men in Ties” are most active and have turned Distributing Bank into Disturbing Bank. The troubled Distributing Banks can be nationalized if required.
* Transmitting Banks: Which can act as intermediaries between Generating Bank and Distributing Bank and can keep the financial system running. Transmitting Banks should be completely overtaken by government to keep the system working.
So by employing Divide and Conquer Strategy
* Generating banks take deposits from public and pass these deposits on to Transmitting banks at pre approved rate of interest. Government pays them few basis points more to cover their expenses and profits.
* Transmitting banks then should provide money to Distributing Banks at pre approved rate of interest. “Men in Ties” in Distributing Banks should be free to invest but should be of greater scrutiny. The troubles ones should be nationalized.
* Government should take the role of Transmitting bank and ensure liquidity in the system.
In this model if there is trouble in any entity, it can be treated as an isolated case. Government can nationalize the trouble entity or restructure it as required with out jeopardizing the whole financial system.
Divide and Conquer is an old strategy of every politician. Obama should not have problem in using it in banking industry for larger public good. Will “Men in Ties” like to wear government hat? Well, one can’t choose color of tie some times!!