Privatise albatrosses into golden geese

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What a difference four years make. In 2008, the collapse of US housing juggernauts Fannie Mae and Freddie Mac was averted only after a $200bn bailout from the Treasury.

Fast forward to 2014 and Fannie and Freddie now pay around $45bn in annual dividends to the Treasury – transformed, somehow, from albatrosses to golden geese.

Today, debate rages in Washington over how to restructure these government entities to limit future liabilities in the event of another housing market crisis. However, a growing chorus of supporters would like to re-privatise some of their business so the government can capitalise on their substantial dividends.

Fannie and Freddie’s transformation is not a unique or isolated event. Years of financial repression has successfully reflated global asset prices and governments are keen to realise some of the value in their portfolios. In the UK, the government is using buoyant financial conditions to extract value from its massive bailout of the banking system. It has sold 6 per cent of its 39 per cent stake in Lloyds to institutional investors, and its 81 per cent stake in Royal Bank of Scotland is not far behind.

While shedding assets might be the priority, privatisation will engulf a broader swath of government assets in the years ahead. Long-term secular forces such as ageing populations make most countries’ fiscal positions untenable, while fierce global competition and disruptive innovation are also putting pressure on unemployment. These challenges were always going to be formidable, even without depleted fiscal reserves. Governments are left with no option but to privatise both crisis and non-core assets to reduce debt to more sustainable levels.

Across the world, governments are trying to jettison such assets. The UK government finally sold 60 per cent of its stake in Royal Mail, while non-core assets such as parts of the National Health Service, education, probation services, roads and nuclear waste disposal are likely targets of its privatisation agenda. In the past, outsourcing was often more expedient but buoyant markets and an urgent need to shed debt have tipped the balance.

In Europe, Enrico Letta, the Italian prime minister at the time, announced a first round of privatisations in November, to raise €10bn-€12bn and stabilise the country’s debt to gross domestic product ratio at around 132 per cent of GDP. Further bold moves will be needed to “right size” Italy’s debt to fit its economic reality.

Similar trends are under way in Portugal, where the government, under the aegis of an IMF programme, has implemented a framework for privatisation, earmarking Galp (the gas and energy provider), CP Carga (the railway freight service), ANA (the airport operator), CTT (the postal service), RTP (the broadcaster) and Caixa Geral de Depósitos (the largest bank).

Ireland has identified entities such as Bord Gáis (the semistate energy company), Coillte (the state forestry body) and Aer Lingus (the national airline). While prices for early privatisation efforts fell short of expectations, current upbeat sentiment sets the scene for Ireland to reduce its indebtedness from 125 per cent of GDP to more manageable levels.

Privatisation is also gaining momentum across emerging markets, but for different reasons. The boom in economic growth fuelled by cheap money was not met by tighter fiscal policy, but by complacency, as seen in Brazil and Turkey, for example.

Late last year, the Mexican government passed bold measures to reform its energy markets. Foreign companies will now be able to participate in the extraction and distribution of Mexican oil, which have been stymied by years of under-investment. Similarly Peru has passed legislation to permit an injection of private capital into state energy company PetroPeru. China has embarked on a clear plan to restructure state-owned enterprises and liberalise financial markets and its tightly controlled capital account.

For investors a credible privatisation drive will reduce long-term tail risks surrounding public-sector insolvency. It will also provide selective opportunities. Royal Mail’s privatisation was not only greeted with enthusiasm for the shares, it also boosted the broader equity market and sterling. Privatisation drives should improve efficiency, as financial services, transport and energy infrastructure, health, education and postal services are delivered more efficiently. Governments will lighten regulation around the activities they privatise, as well as price assets attractively to ensure their efforts succeed.

In 2008, Fannie and Freddie set off a financial maelstrom. In 2014, they are at the forefront of a wave of privatisation that could sweep the world economy. With reduced risk, heightened confidence, increased efficiency and less restrictive regulation, this global effort to restructure will be good for both markets and investors.

Subitha Subramaniam is chief economist at Sarasin & Partners