The sovereign exit strategy for bank shareholdings

March 30, 2010

There are very few investors for whom a 0% return is just another arbitrary point on the real-number spectrum. In theory, the difference between a +10% return and a +15% return is the same as the difference between a -3% return and a +2% return. But in practice, the latter is much more important, because it spans the crucial zero bound: it’s the difference between making money and losing money.

Much has been written on the behavioral economics of loss aversion, where the pain of losing a certain amount of money is nearly always greater than the pleasure of gaining an identical amount. And what’s true of a country’s citizens is often true of its government, which is why the question of whether or not governments are making a profit on their bank bailouts is an interesting and important one.

Which is not to say that the super-smart dsquared was wrong when he left this comment about whether it would constitute speculation for Treasury to hold on to its Citigroup shares. Quite the contrary, he’s absolutely right:

I had heard the saying “an investment is just a speculation that went wrong”, but it’s a joke, not a sensible principle of money management and not something that can be reversed to give an exit target. If the Treasury is speculating now, it was speculating when it was in the red.

But the point is that if Treasury continues to speculate now, it’s mere speculation. When it was underwater on its investment, it at least could say that it was holding on to its stake until the share price rose enough that it could get its money back. Yes, that’s a form of speculation too. But it’s somehow a more acceptable form of speculation to hold onto an investment in the hope that you won’t lose money than it is to hold onto a profitable investment in the hope that you’ll make even more money.

Indeed, the whole argument about whether or not banks should mark their assets to market is at heart an argument about this very question. If banks hold loans on their books at par, even if they could never get 100 cents on the dollar for those loans in the secondary market, they’re essentially speculating that the value of the loans will return, over time, to more than they lent out in the first place. But they don’t call it speculation, they call it “commitment to our valued clients through thick and thin”, or something like that.

Sovereign investments in banks, it seems, work much the same way:

Switzerland made a profit after selling a 9 percent stake in UBS in August, saying it was confident the bank was on a solid enough footing for it to retreat.

Britain is expected to start selling shares in Royal Bank of Scotland and Lloyds, although that would not happen until after the general election, expected in May.

Share prices for RBS and Lloyds have risen close to the average price at which Britain bought its stakes and the government is becoming increasingly confident of making a profit on the billions of pounds it has pumped in.

A full exit could take many years in many countries, however. Sweden, which pioneered NAMA-style schemes, is still a big shareholder in Nordea after it stepped in to rescue lenders in the early 1990s.

The pattern here, from the U.S. to Switzerland to Britain to Sweden, is clear: you hold on to your stake until you’re in the black, and then you sell it. Yes, that’s a form of speculation. But it’s clearly an acceptable one.


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