Learn from China's experience

Americans should heed warnings from China about what happens when the state controls banks.

In his excellent column in the April 4, 2009 WSJ, 
Obama Wants to Control the Banks, Stuart Varney writes:

I must be naive. I really thought the administration would welcome the return of bank bailout money. Some $340 million in TARP cash flowed back this week from four small banks in Louisiana, New York, Indiana and California. This isn't much when we routinely talk in trillions, but clearly that money has not been wasted or otherwise sunk down Wall Street's black hole. So why no cheering as the cash comes back?

My answer: The government wants to control the banks, just as it now controls GM and Chrysler, and will surely control the health industry in the not-too-distant future. Keeping them TARP-stuffed is the key to control. And for this intensely political president, mere influence is not enough. The White House wants to tell 'em what to do. Control. Direct. Command....

...After 35 years in America, I never thought I would see this. I still can't quite believe we will sit by as this crisis is used to hand control of our economy over to government. But here we are, on the brink. Clearly, I have been naive.

I had lunch yesterday in Beijing with friends, a retired high level Chinese diplomat and former member of the Standing Committee of the National People's Congress and also a very successful Chinese business consultant with a U.S. business school graduate degree.  Both are quite attuned to current U.S. politics and economic matters, and the consultant has high-level dealings with China's largest banks.

We discussed how with their legacy as state-owned institutions, Chinese banks had historically put political considerations at the forefront in their lending decisions, with little regard to credit-worthiness and profitability.  Recognizing that China's economic growth requires its major financial institutions to move away from purely political lending decisions towards a private-ownership profit-based capital allocation model, the central government has prepared its major banks for the transformation by spending large sums over the past decade to add to their capital and rid them of toxic loans that resulted from years of politically motivated lending.

My friends offered that with the move to partial private ownership, Chinese banks acknowledged that they had much to learn from U.S. banks in the area of risk management and had been in the process of doing so.   But the U.S. financial crisis has put several of the Chinese banks in the position of now being the world's largest and most influential with the dilemma of where to look for assistance in developing systems to manage risk in light of the colossal failures in the American banking system.

I asked whether they were aware of the Community Reinvestment Act and American congressional pressures and incentives that strongly encouraged U.S. banks to make unsound loans in furtherance of "affordable housing".  They were, and we concluded that the American banks had succumbed to the same problem--government interference in bank capital allocation--as Chinese banks.  We all hoped the U.S. will now have learned its lesson.  

China still has a long way to go in reducing the influence of the State in bank lending decisions, as do U.S. financial institutions in the area of risk management.  A necessary (though not sufficient) condition for sound risk management in our banking system is freedom from political pressure to make unsound loans.  We ignore Stuart Varney's warning that we are moving in the direction of government control at our own peril.
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