A second, more subtle explanation focuses on the massive transfer of private debt onto government balance sheets. The message is fairly simple. The nationalisation of private debt injects considerable inefficiency into the economic system, inhibiting Schumpeter’s process of Creative Destruction that is essential in a market economy and needed to maintain the private sector. In short, the recent massive bailouts by national authorities of their financial systems in some countries amount to nationalising private sector debt with fiscal resources. In countries without fiscal headroom and lacking reserve currencies, such as Hungary, Romania and Ukraine, the IMF jumped to the rescue with sovereign lending that has basically nationalised the losses of the private sector – what Joe Stiglitz calls ‘Ersatz Capitalism’: the privatising of gains and the socialising of losses.
Another example of a massive transfer of private debt to the national balance sheet without nationalising the private sector was of course in Japan in the aftermath of the asset bubble. For the better part of the 90’s the Japanese government extended forbearance to a banking system that in turn extended forbearance to the corporate sector through the infamous “evergreens”. Japan’s financial system struggled with non-performing loans. The forbearance and continuing partial recapitalisation of the banks, without decisive measures to attack the core problem ‑ a distressed private sector – ended transferring the debt to the national balance sheet. The outcome is well known. Japan has one of the highest public debts in the world, and the corporate and banking restructuring process was partial. Japanese banks are some of the most undercapitalised banks in the world.
What is the solution? First, it would be far more appropriate not to recapitalise banks and introduce a hard budget constraint that forces banks to restructure their private sector clients. Equally, it would be far more appropriate, as in the case of the previous Ukraine restructuring, for countries to declare a standstill and restructure their debt, as opposed to forfeiting prospective growth. Second, emerging markets and developed countries alike are well advised to improve the infrastructure for corporate restructuring as opposed to taking private debt on sovereign balance sheets.
Of course the nationalisation of private debt in order to preserve financial stability raises ethical questions such as whether it is morally acceptable to in-debt middle class citizens for the sake of saving large banks. This is a normative issue not addressed here.
Michael Pomerleano was visiting scholar at the Asian Development Bank Institute in Tokyo