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Nationalization
NATIONALIZATION....Is it time to start nationalizing the U.S. banking industry? Felix Salmon says yes:
Both Citigroup and Bank of America are down more than 20% in early trade today, and I imagine that Hank Paulson and Tim Geithner are starting work on yet another weekend deal of some description....I can't see a solution to this problem short of nationalizing both Citi and BofA, and summarily firing the hapless Vikram Pandit along with the overambitious Ken Lewis.
"Nationalization," of course, is a dirty word in the United States. We're a very immature country, after all....But it's the right thing to do, and that's been clear for a while now. We can ill-afford to leave the health of the whole financial sector hostage to an ideological distaste for the concept.
The bandwagon for nationalization seems to be getting up a good head of steam, and whenever that happens it's worth slowing down a bit and articulating the opposing case. A lot of the sentiment in favor of nationalization appears to be driven by admiration for Sweden's "quick and decisive" action to clean up its own banking mess in the early 90s, so let's take a look at what Sweden did and didn't do. First off, here's what they didn't do:
They didn't act all that quickly. The real estate crash and the resulting credit losses began in late 1990, solvency problems started to become acute in late 1991, and a variety of treasury guarantees and capital injections were tried for another year after that. (Sound familiar?) It wasn't until late 1992 that the Swedish government finally took serious, systemic action.
They didn't nationalize the banking system. Only one bank, Gota, was taken over, and that happened only after it had collapsed. And aside from Gota, only one bank received a substantial amount of capital injection: the state bank, Nordbanken, which had much bigger problems than most of the private banks.
Generally speaking, they didn't fire existing bank management.
So what did the Swedes do? The main thing was simple: in late 1992 the Swedish government guaranteed all bank obligations throughout the system. They did this immediately for Gota after its collapse, and two weeks later for everyone else.
What else? Not too much, actually. An agency was formed to dig into the portfolios of nearly every major bank, and this resulted in a capital requirement guarantee for one bank that was never used. In addition, the shareholders of Gota and Nordbanken were mostly wiped out.
So what are the lessons for us? First, we don't necessarily need to nationalize. If we have to, then we have to, but with the exception of Gota that's not what the Swedes did.
Second, we could consider a systemwide guarantee of all bank obligations, instead of the one-offs we've (partially) applied to Citi and BofA.
Third, we still have to take care of the toxic assets clogging up bank balance sheets. The Swedes did this for Nordbanken and Gota by hiving off "bad banks" to handle the valuation and eventual sale of their bad assets. We could do the same thing here, which is basically what TARP was initially intended to do. But whether you call it "TARP" or a "bad bank," it's pretty much the same thing, and it presents pretty much the same main problem: figuring out how to value and eventually dispose of the toxic waste. Painful or not, though, it needs to be done, and I never entirely understood the mockery that was directed at this idea back when TARP was initially unveiled. Everyone agrees that recapitalization is essential, but one way or another the other side of the balance sheet needs to be addressed too. This mess won't get cleaned up until the toxic waste is cleaned up as well.
So is this what we should do? I don't have the financial chops to say — though certainly government ownership makes the "bad bank" idea a lot easier to implement. But if we think the Swedish model is worth taking guidance from, the path ahead includes systemic debt guarantees, capital injections, a bad bank for toxic waste, and nationalization only as a last resort.
Well, Kevin, while you are making some good points in how the Swedes tackled their problems in the 1990s, it also seems rather obvious that you are one of the persons with what Yglesias calls, a 'distaste' for the concept of nationalization.
I am deducing this from the fact that Salmon is talking about two specific cases, Citi and BofA, respectively Vikram Pandit and Ken Lewis. Yglesias deals with the issue why there is so much reluctance to use nationalization as a means to solve the problems in the financial sector.
You in turn talk about the fact that the Swedes didn't nationalize 'the banking system'. Well no, they didn't. But is that what either Salmon or Yglesias are arguing for? Taking over the SYSTEM, i.e. all banks, even the ones that are not in distress? Then you say that 'generally speaking' the Swedes didn't fire existing bank management. Again, that is true, but is that what Salmon is suggesting? I suppose there are some more people in the management of Citi and BofA than Pandit and Lewis.
I wouldn't go so far as to say that your distaste towards the idea of nationalization is ideological in nature, but I am prepared to suggest that turning two banks into 'the system' and two managers into 'existing management' would appear to be symptomatic of the possibility that there is something of that in the corresponding corner of your mind.
This crisis is on a whole different level to the Swedish one. It is global and nature ie it involves institutions whose failure could cause worldwide systematic damage. We will not get a go around on this, the excesses involved are much greater. Swedish bankers (of whom I know a fair few) are still Swedes, they take social responsibility seriously and would not need physical nationalisation to alter their behaviour at government request. US bankers I am not so sure. I still think Deng was right when he said "It doesn't matter if a cat is black or white, as long as it catches mice"; we need to remember it cut both ways.
Good post. Thanks...
> An agency was formed to dig into the portfolios of nearly every major bank
This is something the US should do immediately (at least for all banks accepting TARP funds) to get a handle on this...
This has nothing to do with the post but, kevin, can you address last weeks 60 minutes episode on oil speculation? It was completely ignored by everyone.
Obama is trying to create jobs but the bank bailouts have resulted in huge acquisitions and mergers instead of stability and after the acquisition-40,000 plus employees get laid off adding to the Unemployment roles and making bigger CEO Bonuses possible-Am I the onlty one that has a problem with this? It seems very counter productive on every level!
Forget the Banks-Nationalize the energy Companies starting with Big Oil who are currently charging considerably more than the $1.50 per gallon that $37 per gallon Oil would require-G.W. has deregulated everything and done away with windfall profits taxes and utility regulation and we should be surprised when corporate greed takes over?
As I have understood their process, I believe you have minimized a very important action by the Swedes, and that is the following:
"What else? Not much, actually. An agency was formed to dig into the portfolios of nearly every major bank, and this resulted in a capital requirement guarantee for one bank that was never used. In addition, the shareholders of Gota and Nordbanken were mostly wiped out."
Now, I imagine that every bank (and Republican) will call this specific action Nationalization, Socialism, Communism and worse. No private company wants the financials of their portfolio scrutinized closely and/or publicly. They consider this intellectual property and on that, they have a point. Taking this information public, for the banking system as a whole, actually would be the bigger part of "Nationalization". The kind of Nationalization that you mention is not even close to being contentious now, because we already have that when banks actually fail.
However, this "Nationalization" of the banking information was the policy that rooted the problems out of the system and provided transparency to the quality of all other bank holdings. This in turn eliminated uncertainty and allowed for the minimum intervention that you cite, and thus, also the efficient use of government resources.
Now, the actual presence of Nationalization per se, a key, but as you note, minimal part of their policy reduced moral hazard and quarantined the "toxic" influence of bad holdings on the rest of the bank system. Yes, they took over a couple banks before they went to the point of actual failure. However, as you note, it took them a while to come to that point, and how long would their influence on the rest of the system remain if they were allowed to struggle until failing? The government could have had other banks "eat" the bad banks, but then that is just incorporating their bad holdings into the system, rather than eliminating it, something we are now finding works rather poorly, as the government rescues Bank of America from its indigestion.
So what happened when banks were forced to let go of their intellectual property to the government? It certainly improved the entire system. It improved banks with good portfolios as private enterprises by improving the capitalization through their share price. However, it may well have changed an individual bank's competitive position with respect to other banks. So the banking system as a whole improved more than most individual banks. Also, for every bank, there existed a great deal of uncertainty as to the winners and losers of the process, as surely there would be, as that was the point, to find the losers. So, I would expect banks to resist this type of policy.
However, it seems like the most efficient policy to the other side, and the banks may not be able to escape simply because we will run out of ability to perform more expensive alternatives. I like to test my ideas, so I waiting to see if the Obama administration comes out with some policy similar to the Swedes in the next 6 months.
When a bank lends the dollar that you have deposited to ten other individuals, it creates money. At a minimum, that function should be heavily regulated to ensure that the loans made with your dollar are safe loans. The bank should not be able to use your deposited dollar to "invest" in high risk instruments.
Were banks structured in a manner to ensure that your deposited dollar was used to make safe loans, as they once were, there would be no reason to "nationalize" them. Other private entities could raise capital in standard ways and invest in riskier loans and instruments, and plenty of so-called "innovation" could occur without money creation and the subjecting of your deposited dollar to undue risk. Of course, they too would need to be regulated, at a minimum, to ensure transparency.
Nationalizing the money-creating and safe loan function is a way of returning banks to what they once were. There is absolutely no downside to this. Once again, a vigorous private sector -- investment companies, hedge funds, etc. -- could lend in more risky ways and "innovate" all they wanted to without loading up bank balance sheets with "toxic" assets.
There is absolutely NO good economic or social reason to allow banks who hold the deposits of the public to engage in risky lending or investments.
So when you speak of "nationalizing," it would be good to distinguish between the two functions. Lending and money creation, on the one hand, should be a relatively low risk enterprise with low to modest returns; "investing," on the other hand, may include riskier ventures. The former might be nationalized, the latter should not be.
Government has the expertise to do the former. It simply requires following rules; a chimp could do it. Government does not have the expertise to do the latter. Nationalize the former, not the latter.
I think people are using "nationalization" as shorthand for the government "getting all up in" the banks books in order to force asset valuations down to realistic levels. And once that happens, many banks will end up being insolvent and run by the government.
However, I'm pretty sure that the US does not have a paygrade that provides for tens of millions of dollars per year to f-up the economy.
Kevin,
1. What is your source of information on the Swedish details?
2. As SRW1 above points out, almost no one is talking about nationalizing the "banking system". To suggest that they are is a strawman.
3. You mention that they didn't act all that quickly, but don't address the question of whether that was a mistake. I suspect it was.
4. Most importantly, what did the Swedish gov't get in return for their capital injections? Equity. The devil is in the details that you omitted. I was happy to hear that TARP funds were to be used for capital injections instead of buying toxic assets at artificially inflated prices (also known as a gift of taxpayer money to the banks). I was quickly disappointed by the terms: 5% interest, 0% pre-pay penalty and IIRC 15% convertible to common stock. What a joke!
5. Taking equity in return for capital injections is nationalization. The percentage of common stock held by the gov't indicates how nationalized it is. There are cases between 0% and 100%.
6. As DWN above points out, digging into the portfolios and writing off bad loans was one of the most important parts of the Swedish plan, yet you minimize it. Worse, Paulson and Bernanke have been bending over backwards to do just the opposite - hide who's in trouble. That's the excuse for the sweetheart capital injections via preferred shares - they wanted all of the top banks to get the same treatment so nobody would know who's in trouble. Only by making it a sweetheart deal could they get banks that didn't need it, like Wells Fargo, to accept the terms.
Bottom line: the gov't has been busy handing out taxpayer money to badly run banks. Sweden insisted on serious equity in return, and that is the only way they recouped the taxpayer investment. What has the US gotten in return for their handouts? Almost nothing. The difference is the difference between a responsible rescue plan and Welfare for Wall St.
Good comments above! Willem Buiter had a posting on this at his Maverecon blog yesterday -- Time to Take the Banks into Full Public Ownership. Excerpt:
I believe that costly partial state ownership and the fear of future state ownership (partial or complete) are themselves discouraging banks from lending. To minimize moral hazard, capital injections into the banks by the state and other forms of financial assistance by the state should be priced punitively and have other conditionality attached to it that is unpleasant for current shareholders and management (the dismissal of the incumbent top executives and the board; restrictions on dividend payouts and share repurchases until the state has been repaid; restrictions on executive pay and on bonuses etc.).
But if the state's financial assistance is priced punitively or has other painful conditionality attached to it, existing shareholders and management will do everything to avoid making use of these government facilities... I believe that this mechanism is at work in a powerful way both in the UK, the US and in continental Europe.
Nationalizating is just going to be another excuse for our government to dip their claws into the peoples money and misuse the funds in the way they misuse social security funds and everything else.
It's going to come to downsizing as the only realistic option, so that if Banks do fail for misusing and being un-conservative with the money, than they fail This talk of nationalizing is going to further seperate conservatives voters from their corporate dependent Party, the GOP. This is going to decrease the size of the Republican Party even more than it already is decreased, a party that longer represents people, but instead exclusively the special interest of corporations.
The conservative voter is going to be right in insisting that the government keep it's greedy hands off the banks. Downsizing is the only answer for what happened with this massive bank bailout problem we're having right now.
For the comment that now "every Republican will say..."
It's a cold day in Hell, and the pigs are flying. My Florida Republican mother (rapidly becoming a big fan of Obama, btw), said to me last night: "why don't we just admit that we're nationalizing the banks and get it over with? It will cost us a lot less and get us to the 'fixing' step faster."
Let's nationalize the port-potty industry while we are at it - what the fuck?
How is this new blog gig working out for you, Kevin? The two and a half people who read this blog and post under different names, must buy a lot of shit from Mojo, to justify your salary!
According to the NYT this morning, the Swedish plan is essentially what Carol Bair, the head of the FDIC, whom Obama has asked to stay on, would like to do. But she couldn't get Paulson and Bush on board (partly because I'm sure Paulson had a reflexive negative reaction to the gov't cleaning up and/or dictating to the banks, especially the mega-banks run by his friends).
Alex: Several sources, but the main one was Peter Englund's 1999 article in the Oxford Review of Economic Policy.
As for your equity comment, I agree. The terms we got for our equity injections were poor, partly because Paulson forced everyone to take the same deal. However, for comparison, note that Sweden only pumped substantial equity into two banks, and one of them was already state owned.
And yes, equity injections are partial nationalization, though I'm not sure that's a useful term until the equity stake gets fairly large. Of course, it's also worth noting that even if you don't count Citi and BofA, we have nationalized Fannie Mae and Freddie Mac, shuttered a whole bunch of large banks, forcibly rescued several investment banks, and nationalized AIG in all but name. So we're probably already about as far down the nationalization road as Sweden ever got.
One other note: the key policy action from the Swedes was the systemic bank guarantee they issued in late 1992. If we think the Swedish model is worth learning from, that's the big takeaway, since it almost immediately stabilized their credit markets. And they did this in spite of the obvious moral hazard issues. Paulson has kinda sorta done this for Citi and BofA, and been roundly criticized for it, but I wonder if it's such a bad idea? In fact, maybe Paulson's problem is not having the guts to do a full systemwide guarantee instead of the small scale ones he's done so far.
(However, there may be bigger issues involved here that I'm not aware of. Guarantees for the American banking system in 2009 might a very different animal than for Sweden in 1992.)
"Second, we could consider a systemwide guarantee of all bank obligations..."
Who is the 'we' here? We the de-facto Bankers without benefits?
'We' will guarantee the banks obligations, while they will raise the interest on ours?!
WTF,-Kevin Drum?!
Kevin:
I tried to comment on Saturday under a different email (same name), and it wasn't accepted: it was a brief mention of the Norwegian vs. Swedish approaches to rescuing the banking system, with some links. Later, I tried a different comment, and was told that I'm not allowed to comment.
I'm curious to know how I offended, or what rule I violated.
Thanks,
Marcel
Why even buy the toxic assets? They are worthless at open market.
The more efficient solution is to print money and just give it to the banks in the ammount they need to stay solvent. You'll get inflation, but that's the price of Keynesian policy.
Mick: You're sadly misinformed. "Printing money" is not part of the Keynesian playbook. That's what the people who don't believe in Keynes, like Milton Friedman, advocate.
nationalization
sounds a lot like socialism, my history teacher warned of this back in 1976. Guess the old basturd was right. No wonder they want to control private arms. Lot of people are going to be mad as hell when they realize everything has been stolen away. Damn the jihadist must be tap dancin for joy right about now and stalin may rise from the grave. Please o master beat us some mo.
You are plagiarizing bruce
You are plagiarizing bruce schneier from his book. Atleast have a curtsey to quote and attribute.
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