Some Consequences of Government Ownership of Banks

Posted: Mar 05, 2012 12:01 AM

Despite the substantial and continuing repayment of TARP bank assistance, the U.S. government maintains an equity interest in 371 banks.  A small number of those banks actually have the government as a majority owner.  For instance the former GM financing arm, now known as Ally Bank, has a government interest of 74 percent.  Sadly the United States is not alone in this regard.  The Royal Bank of Scotland (RBS) is still majority owned by the UK government.  And of course the U.S. government owns Fannie Mae and Freddie Mac, even if the Office of Management and Budget denies that reality.

Should we be concerned about all this government ownership of financial institutions?  The small body of empirical literature on the topic suggests a strong “yes.”  Probably the most comprehensive research was published in the Journal of Finance by La Porta, Lopez-de-Silanes, and Shleifer.  The authors find “that higher government ownership of banks is associated with slower subsequent development of the financial system, lower economic growth, and, in particular, lower growth of productivity.”  Let’s keep in mind that the last one, productivity, is ultimately what drives wage growth.  So for several very important reasons we should be doing our best to get the government out of ownership in the financial sector.  Recent research in the Journal of Financial Intermediation confirms these findings, and also finds that political inference is what primarily drives these bad results.

As much as it pains me to say it, the recent suggestion by Paul Myners and Manus Costello in the Financial Times that, in the context of RBS, we are better off as taxpayers taking our losses and getting out of these companies rather than holding out for better returns, is probably correct.  The damage to the greater economy from political interference in the financial system (witness the demands for Fannie and Freddie to take losses to support the housing market) is likely to outweigh the losses to the taxpayer from an early ownership withdraw.