Nationalization for Beginners

“Nationalization” has been the word of the last month, with support not only from the usual suspects, but from Lindsey Graham, Alan Greenspan, and (to some degree, although they won’t say the word) Richard Shelby and John McCain. However, different people ascribe different meanings to this word; in particular, opponents like to define nationalization as the government taking over every bank permanently and turning banking into a government service.

As I see it, there are at least five different meanings of nationalization.

1. Owning more than 50% of the bank, by which people typically mean owning more than 50% of the common equity

This is a red herring, despite Treasury’s complicated efforts to keep its ownership stake in Citigroup below 50%. One entity can have effective control over another with less than 50% of its equity – through stock with special voting rights, or simply by being the largest shareholder. Conversely, one entity can own over 50% of another’s equity, yet not have any control, perhaps because it holds non-voting stock, or perhaps because it simply chooses not to exercise control.

2. Consolidating the bank onto the government balance sheet

Above 80% ownership, things do get serious: at that point, the bank becomes part of the government balance sheet (unless there is some special treatment for the U.S. government that I’m not aware of). This means, among other things, that the bank’s debt becomes U.S. government debt, which increases the potential liability of the taxpayer. This is why, for example, all of Iceland’s banks defaulted on their debt just before being taken over by the state; otherwise Iceland’s citizens would have become responsible for their debts. This is also why it is unlikely to happen here.

3. Turning the bank into a government agency

In this scenario, banking becomes a government service, like getting a driver’s license or going to the unemployment office. Banking decisions – how much to pay depositors, who gets credit, on what terms, etc. – become the province of government bureaucrats. This would most likely be a bad idea, because these decisions – which, collectively, shape the flow of capital through the economy – are best entrusted to the free market. This is why no one is seriously considering this option here. However, when people argue against nationalization, this is often the straw man they are aiming at.

4. FDIC-style conservatorship

This is what the FDIC does when a bank it insures fails. FDIC bank supervisors determine that the bank’s assets are worth less than its liabilities. The bank itself is shut down and its assets are transferred to a new entity controlled by the FDIC. The FDIC attempts to maximize the value of these assets, typically by selling them to another bank or banks. From the customers’ standpoint, little changes during this period: the branches, ATM machines, web site, and so on remain in operation during the transition, except that customer may not be able to withdraw amounts above the insurance limits. If the proceeds do not cover the bank’s liabilities, the creditors lose out, but the FDIC makes sure that all the insured deposits are paid back. Note that going into conservatorship does not mean that the bank is consolidated onto the government balance sheet; the liabilities are not automatically guaranteed.

#4 is what most proponents of nationalization mean.

Those are four different versions of what it might mean to nationalize a bank. In addition, there is another type of nationalization that must be discussed and that, in fact, has largely occurred:

5. System-level  nationalization

Banking in the United States, as in all advanced economies, has always been a public-private partnership rather than an unregulated free market. Banks play a critical role in the economy and therefore enjoy certain protections – such as FDIC insurance – and certain constraints – such as regulation. If the government had failed to act as the financial crisis unfolded, things would probably have gotten much worse, very quickly: not only Lehman Brothers but also Bear Stearns, Fannie Mae, Freddie Mac, AIG, Morgan Stanley, Citigroup, and probably Bank of America would have collapsed, causing trillions of dollars of losses for creditors and counterparties and bringing down other banks in sequence.

Instead, the government, primarily through the Federal Reserve, stepped into the breach. The government is the only source of capital for the banking system; it guarantees a large proportion of bank liabilities, including virtually all deposits and new bank debt; it implicitly guarantees all large banks under the Too Big To Fail doctrine; it ensures the liquidity that keeps the system afloat, both by providing cheap money and by lending against illiquid assets; and it has stepped up buying of various securities on secondary markets in order to encourage lending. In short, the government is where the money comes from, and the government decides on a high level where it goes, through capital injections, loans, and securities purchases. And the government bears the vast majority of the risk.

The net result is we have a semi-nationalized banking system largely made up of some very sick but private banks. As Thomas Hoenig put it:

We understandably would prefer not to “nationalize” these businesses, but in reacting as we are, we nevertheless are drifting into a situation where institutions are being nationalized piecemeal with no resolution of the crisis.

I am all in favor of debating to resolve the crisis. And I think that nationalization should be on the table, rather than being written off as some fundamental denial of the laws of physics.

56 responses to “Nationalization for Beginners

  1. Fortunately, lawmakers are beginning to reach a consensus around conservatorship. Chuck Schumer and Lindsey Graham actually agreed it very well could be the best option on MTP this week. If only they could convince Tim Geithner.

  2. >>Above 80% ownership …the bank’s debt becomes U.S. government debt, which increases the potential liability of the taxpayer.>>
    Don’t confuse accounting with substance. No amount of equity ownership makes you legally obligated to pay debt. What happens to bank debt in practice is another question, but that may be independent of stock ownerhip.

  3. Pingback: An overview of the nationalization debate « Managing Uncertainty by Nicholas Davis

  4. Here is a detailed plan for the banks – from experts who actually know the problem – from the inside. I recommend it.

    As I also wish again for inflation. And repeat that Bernanke could give it to us but just isn’t. Worse than that – he refuses.

    The Institutional Risk Analyst

    What is the Plan? A Discussion With Bill Dunkelberg and David Kotok

    http://us1.institutionalriskanalytics.com/pub/IRAMain.asp

  5. Edward Greenberg

    Thank you Mr. Kwak.

    Now, could you please describe the size of the liabilities owed by the top 4 banks to bond holders and who the largetst bond holders are?

    This would make it easier to understand the extent of exposure to all parties in any – .

    Right now I find that part of the picture to be a bit murkey.

  6. Thanks for this post and all of your posts. This entire blog has been extremely helpful to an economic dunce like me to understand the chaos going on right now.

    I do have a question about nationalization, though. My main concern is how to go about doing it for a few of the most insolvent of the big banks without causing massive runs, short selling, etc. to the other banks. If we decide to nationalize some of the banks, exactly which banks should we nationalize? And exactly how, in a practical sense, do we nationalize these banks and ensure that we don’t see widespread panic everywhere else?

  7. The Big Number:

    I have often wondered if the Obama administration was steering away from the word nationalization for two reasons. The first being the obvious political fallout from the term coming from an administration that is already being called Socialist from it’s critics, but even more importantly fear of what I will call THE BIG NUMBER.

    Many on this site, Krugman etc. have talked of a $1-2 Trillion dollar infusion needed to actually stabilize the banking system. Instead of nationalization / conservatorship etc. are they instead getting to this number but through various channels that add up to $1 Trillion plus but keep that number off the headlines.

    For example: The money to AIG is in some ways a conduit to it’s counterparties, roughtly $140 billion.

    The remaining TARP funds, whether given directly to the banks or indirectly through refi’s of underlying loans that make up various assets another $250 billion.

    The new budget set aside specifically for banks: $250 Billion.

    The TALF plan: $200 Billion in governement funds, perhaps with some private capital as well.

    The new money just authorized to the FDIC, which in my opinion is there to back up at least one big bank after the “stress test” is done: $500 billion.

    Add to that the new moneys recently given to Citi, and I believe we are approaching $1.4 Trillion dollars. Add to that TARP one and we’re pretty close to the $2 Trillion mark bandied about since last fall.

    Could it be that while we all await the grand plan that will break down the wall of credit contraction the moles have been quietly undermining it all along and it will fall just the same?

  8. this has already been mentioned in previous posts’ comments sections, but isn’t the central problem that banks in question have, methodically and necessarily, been ‘internationalized’ and that the real problem is in making those systems work better through greater ‘transparency’, regulation, IT systems integration etc. – seemingly difficult to do with a more fragmented system which seems to be seeking better co-ordinated fixes: http://ftalphaville.ft.com/blog/2009/03/09/53328/one-giant-drop-of-cash-for-mankind/

  9. Suppose there are 2 trillion in bad assets. How much would conservatorship cost the government, what would it be paying for?

  10. Good post. I’m tired of seeing the strawman being used as an argument against #4 myself (especially by someone who wants to be taken seriously, like Blinder).

  11. A great deal of what banks do could be done by a computer program running in a government basement. The IRS knows what you’ve earned throughout your life. That could be the basis for your basic mortgage. If some banker wants to give you a second mortgage because he feels he can access your risk better than the government computer program can, OK, let him give you a second mortgage.

    If the government program wants to give preference to minorities, let the government do it (and let us know how it works out).

    Checking accounts, do we really need them? Every person/company has an account with the government with two numbers, one for you, one for people paying you. Want to make a payment? Tell the government to do it from your account. Same goes for credit cards.

  12. Robert Lind

    For a straightforward explanation and solution of the current banking crisis, see

    http://www.kc.frb.org/speechbio/hoenigPDF/Omaha.03.06.09.pdf

    This 10-minute read was written by Thomas Hoening, head of the Kansas City Federal Reserve, and is understandable by someone with no economic background.

  13. You write:

    “Turning the bank into a government agency

    …This would most likely be a bad idea, because these decisions – which, collectively, shape the flow of capital through the economy – are best entrusted to the free market.”

    The explanation for why this is a bad idea is virtually the same as Timothy Geithner’s:

    “It’s not the right strategy for our country for basic practical reasons that our system will be stronger if it remains in private hands with support from the government to make sure those institutions can play their critical role going forward.”

    It’s basically tantamount to saying: “This is America, and we just don’t do that here.”

    First, there are examples of public banksin the US. We had one in the Great Depression (through 1966, when it was allowed to die). The fine citizens of North Dakota still have one.

    Many people struggle with the notion that banking is really all that complicated (at least, the type of banking we feel is actually productive). Certainly some aspects of banking, like home mortgages, are not complicated. It’s not like the US is taking on extra risk. We already have shouldered the risk (just look around).

    So before calling up the comparison to the DMV, might I just ask: Might it be possible that there are some basic functions of banks that don’t need to be in private hands? For instance, basic retail banking? Savings, CDs, home mortgages (with 20% down payment), etc.?

    What, exactly, are the advantages to keeping these in private hands?

    With riskier ventures – commercial property, mezzanine financing, business loans – I can certainly see a case being made. But for basic community banking, it seems like it’s precisely the _least innovative_ banks that are in the best shape today.

    I am not actually in favor of public banking, but not because I believe govt. agencies are inefficient. In fact, agencies such as Medicare and the IRS which have very defined functions seem to work just fine. And every study I’ve seen suggests they are at least as efficient as private sector counterparts.

    I am against public banking because this concentrates a lot of power in the hands of government, and removes a check on government power (not that having banks in private hands has really stopped govt. from getting access to that information when it wants).

    However, I’d like to hear your reasons why banking is “best entrusted to the free market”.

    Personally, I would rather stop hearing (from Democrats no less) that “Government can’t manage complex things as well as private industry” when we’ve just been treated to a colossal example of how bad private industry is at managing finances.

    I’d rather hear, “We don’t endorse nationalization because the private banking system is an important check on government power and individual liberty.”

  14. I agree with the last post. Well put. My two cents: With respect to option #3 (Government Agency as banks), had all home loans been only available through FHA, for example, we would not be in this mess. Just where did the private banking system add enough value to justify the cost we now have to pay? That said, I understand that Canadian private banking laws do not allow the sort of mortgages that lead to the debacle here.

  15. A letter to Obama – and a good one.

    http://blogsandwikis.bentley.edu/themoneyillusion

    To quote the ending:

    Then ask her why your advisors are putting all their eggs into the fiscal policy basket, despite widespread expectations that the stimulus package will not revive the economy anytime soon. Why aren’t they putting their creative energy into developing highly aggressive, unconventional monetary stimulus plans? The plan was for you to be another FDR, not another Hoover. See what she says.

  16. In fact – I am just going to post the whole letter.

    Beginning of post:

    A slightly off-center perspective on monetary problems.
    President Obama: You need to talk to Christy

    Note: Because Christina Romer and I have both done research on similar topics, I know quite a bit about her views on monetary policy during the Great Depression. Ironically, I was planning this post for today before two things happened:

    1. There was an announcement that Obama’s economic team would meet with Bernanke.

    2. Several commenters including Dilip and R McGarry sent me a link to a paper with her views. I presume it was in the news today.

    In any case, here is the post that I had already planned:

    Mr. President, before taking office many of your supporters hoped that you would be able to turn things around in much the same way that President Roosevelt did in his first 100 days. It is not too soon to conclude that things haven’t turned out that way. After FDR had been in office for two months we were in the midst of the fastest growth in industrial production in American history (industrial output rose 57% in his first 4 months in office.) I think it is fair to say that when you reach the two month point in a few days, output will not be rising, indeed it will probably be falling at one of the fastest rates since the Great Depression. How did this come about?

    In a comment on my blog, Tyler Cowen suggested that you talk to me about my ideas for monetary stimulus. I have an even better idea—talk to Christy Romer, who is also an expert on the Great Depression, and whose opinion I imagine you would trust more than mine. Ask her the following questions:

    1. Why have economists associated with the Democratic party recently placed more emphasis on fiscal stimulus, rather than monetary stimulus?

    I imagine she would say that many economists feel that monetary policy is powerless once interest rates hit zero. Or that the banking crisis must be addressed before monetary policy can gain traction. Then ask her the following:

    2. Do you think that monetary policy is powerless once rates hit zero?

    For her answer, I don’t need to use my imagination, here are her own words:

    “A second key lesson from the 1930s is that monetary expansion can help to heal an economy even when interest rates are near zero.”

    3. Then ask her why FDR was so successful in boosting the economy in early 1933 when much of the banking system was shutdown. Was it monetary policy or fiscal policy?

    I think she will have to say monetary policy, as the evidence overwhelmingly points in that direction.

    4. Then ask her why your advisors are putting all their eggs into the fiscal policy basket, despite widespread expectations that the stimulus package will not revive the economy anytime soon. Why aren’t they putting their creative energy into developing highly aggressive, unconventional monetary stimulus plans? The plan was for you to be another FDR, not another Hoover. See what she says.

    end of post:

    The link again

    http://blogsandwikis.bentley.edu/themoneyillusion/?p=546

    First an inflation and then the banks – that is what we need.

  17. Thanks for the clear and concise explanation of the different meanings of nationalization. Hopefully this will be shared with others so at least the discussion/debate can have a more consistent foundation. Based on performance to date, there is little doubt that at least a few of the major financial institutions need to be restructured and the best way to do so is through some form of bankruptcy under the protection of the courts, which would allow for more radical and swift changes then would otherwise be the case, and be backed by government guarantees for the depositors and some % of the amounts due to creditors. Re-privatization of a viable institution would be the end game. Any other approach will take longer, be more easily influenced to move in less effectice and efficient ways, and ultimately be more costly to everyone.

  18. Don’t forget Geithner’s proposed $1 Trillion PPIF Fund; intended to provide incentive for investors to please buy the toxic paper.

    Add this to the rest of the funding you indicated, and we’re over the $2 Trillion mark.

  19. Pingback: Nationalization For Beginners « SLU Public Finance Spring 2009

  20. donthelibertariandemocrat

    I don’t accept that complexity is the big problem. Going forward, Citi’s plan is to sell many of its assets, like Monex, Nikko Cordial, and possibly even Banamex. These are functioning business that don’t rely on Citi for everyday decisions, as far as I can tell. There are legal problems, as with Banamex, but I’m not convinced at all that the FDIC couldn’t do a better job of selling these assets than Citi, since most potential buyers don’t have a lot of faith in Citi.

    Nor do I accept the domino or contagion theory, or even the liquidity problem, although they are possible. The main problem at the time of Lehman was uncertainty. I don’t believe that the problem here is certainty. I think that there is a pretty clear idea of the tab, and it’s very large.

    The real problem is that many foreign creditors, like China, seem to be claiming that they had an implicit guarantee from the US to honor these debts in the same way that we honor US debts. This is a very large claim. The government is pushing this problem down the road in the hope that Citi can deal with issue without us guaranteeing the claims. Unfortunately, this looks like an implicit guarantee that we’re trying to avoid paying. As Zero Hedge had it:

    “In a liquidation of a U.S. insured depositary institution, the 10-K notes that U.S. deposits would have priority over deposits outside the U.S., as well as over parent company claims. But we can’t imagine the new administration will want to precipitate an international crisis over whose-deposits-get-paid-off-first.”

    The problem of the price and precedent are indeed an awful predicament, but pushing the problem down the road isn’t a policy without risk.

    At least, this is one other view.

  21. Who has the real power over the business decisions? If that power is explicit it is easy to know if Nationalization is in place like for example Chavez in Venezuela. If that kind power is tacit then it is ambiguous to know if banks are or will be Nationalize. Bsed on some facts what Greenspan and others may be yelling is “Made Nationalization Explicit for the Rest of the Word”. This will have inmeadiate effects over the world order in the forms of Trade Barriers. The recent article for the FT…. http://www.ft.com/cms/s/0/cbc200e6-0cda-11de-a555-0000779fd2ac.html…about the reluctance of the Euro Zone for another stimulus for had made an explicit challenge to the US about making an explicit statement of whether or not Nationalization will take place.

  22. Thanks, James for this.

    I hear you when you call #3 a straw man, but just WHY is this true?
    “3. Turning the bank into a government agency…This would most likely be a bad idea, because these decisions – which, collectively, shape the flow of capital through the economy – are best entrusted to the free market.”

    Q1: WHY are thes decisions best left to the free market?

    Q2: Is this the same free market that has gotten us into this god awful mess in the first place?

    Q3: Do you think that any bureaucrats could get us into something this bad?

    Q4: Given that these freemarketeers are the people that Bush wanted running our now GOVERMENT-RUN Social Security system, how in the world can we think that government bureaucrats can’t run banks, if they can run SSS?

    YES, call my a Beginner, if you want. But let’s begin with basic questions about assumptions –

    Q5: Has that assumption – that the free market is a magical know-it-all – been repeated and believed for so long that those INSIDE that system maybe can’t see it clearly?

    I just trust the free market about as far as I can throw the Titanic – filled with ocean water. WHY should I believe this assertion to be true?

    Q6: Which is worse – a straw man assertion or scam artists running our banking system?

    As much as I hate going to the DMV or County Clerk’s office, give me those clerical types over the Citi and BOA and AIG and Bear Stearns and Wall Street and the Merc and Chase and . . . . who, all they have done is suck money out of our system, and are even now sucking what may be the last blood out of the goose that laid the golden egg – the U.S. economy.

  23. James: “If the government had failed to act as the financial crisis unfolded, things would probably have gotten much worse, very quickly: not only Lehman Brothers but also Bear Stearns, Fannie Mae, Freddie Mac, AIG, Morgan Stanley, Citigroup, and probably Bank of America would have collapsed, causing trillions of dollars of losses for creditors and counterparties and bringing down other banks in sequence.”

    Why, if the free market is the best way to do all this is government stepping is? Free market is GOD. If government is just the sucker-of-last-resort, buying issues that no one else wants, how is that good for any of us? That really blows, that all THESE companies (and they ARE just companies) are to be saved, while tens of thousands of others are closing their doors right and left? Some free market!

    Oh? Them failing would have cascaded through the economy and brought down the entire world economy? And what is being done right now but hesitation, while their stock values drop through the basement – and are taking down the economy, anyway?

    I am only the 5.9 billionth person to say this, but let ‘em fail. Waiting for the other shoe to drop is exactly what everyone did last winter when the sub-prime sh** hit the fan, with everyone HOPING that the worst would not occur. And now, they are doing the same thing. In September, it was obvious that the best option was the Swedish one, BUT NO ON HAS HAD THE BALLS TO PULL THE TRIGGER.

    TAKE ‘EM OVER, throw the crap out, sell what you can, fire the village idiots who failed (yes, FAILED), and get all the uncertainty the ‘f’ over with. We can’t let events dictate when the bottom is reached. We have to take the bull (no pun intended) by the horns, send it to the bottom, and THEN we can start on the road back up.

    I’ll tell you what: Give me one of those billions, and then give me the Swedish option trigger and the authority to pull it. I WILL pull it and put everything in motion, and then after they all take their lumps, I will buy an island somewhere. If I fail, people can point at my island and say there is where the idiot lives. If it succeeds, I will just want some peace and quiet.

    Waiting is the WRONG thing to do. Ask Hoobert Heever.

  24. Somebody needs to make a clear quantitative estimate as to the time it would take to put Citibank into receivership and resolve the asset problem.

    If the private sector was a good rational investor with a long term horizon it would have invested in alternative energy, conservation, and energy, the tried and true areas where very significant gains can be met. Instead Obama talks about at least funding this.

    State enterprise has many decided advantages. It is true that they are likely to foster corruption but whether the corruption is any larger than what we have seen already by private entities remain to be seen.

    One point not often made is that private capital is hobbled by a 1919 court decision, the Dodge Brothers vs. Henry Ford which requires corporations to maximize short term profits and is still enforced by the courts. Until you allow the corporations to plan with a long time horizon as they do in Japan or as Warren Buffet does with Berkshire, you are at a competitive disadvantage with a private economy.

    The state could set up am infrastructure bank to finance transportation, and education. This bank could finance highly visible projects like student loans etc. Its time horizons could be as long as one likes.

    The history of state run enterprises in a mixed economy should be studied more carefully before one draws any definitive conclusions. Its by no means clear what one will find if one looks closely. Banks are effectively state run in times of stress and the advantages might all be with state agencies. This is an empirical question. We simply do not know the answer.

  25. I am actually trying to understand how we are not already, “nationalized”. A banks product is, well money. As you point out the only place to get it created in our system is from the government. They dictate the terms, amount, and who gets the capital. Now, we as tax payers might not go straight to the Federal Reserve to draw out our money, apply for our loans, and deposited our paychecks, but we are ultimately affected by what the Fed does every time. If there is no Federal Reserve, then there are no banks as we know them.

    This is like calling OPEC “oil producers”. They ultimately have never produced a single drop of petroleum. The Earth is an “oil producer” and every country that has access to that “capital” is but an agent of that bank. They are bound by the constraints and terms of the originator.

    If there is one thing that strikes me is that we haven’t “nationalized” enough. The government will send federal agents to kick your door in and haul you off to jail if you print money. But they encourage credit. So if send people a plastic card and tell them to “use it like money”, that is fine? How will this not have the exact same affect as printed money on the system? I thought it was imperative for the US government to control the value of the dollar. Allowing people to give away artificial capital means directly devaluing the dollar. Why isn’t credit not controlled like actual money? How is its affect different then dumping a large supply of counterfeit money into the system? Doesn’t both allow artificial capital to be used to artificially drive up the market prices of goods and services with out any real backing to the asset?

  26. Why not do nothing and just guarantee the liabilities? It might not cost anything to follow that approach. Here is Buffet on the Toxic assets held at banks and why they are the best investment out there today.

    http://brontecapital.blogspot.com/2009/03/fools-seldom-differ.html

  27. Raivo Pommer
    raimo1@hot.ee

    Rumenien ja Lettlands geld

    Die Reaktion fiel gelassen aus. Obgleich nach Ungarn und Lettland mit Rumänien nun der dritte osteuropäische EU-Mitgliedstaat die Europäische Kommission in Zahlungsschwierigkeiten geraten ist und um Hilfe gebeten hat, zeigen die Finanzmärkte nur verhaltene Reaktionen.

    Die Landeswährung Leu wertet zwar um 0,8 Prozent auf 4,3077 Leu je Euro ab, doch ist sie damit immer noch unter dem Tief von Anfang Februar bei 4,3614 Leu. Die Kurse der rumänischen Staatsanleihen gaben immerhin leicht nach.

  28. Pingback: Comentário semanal « Notícias do mercado

  29. How about this then for a completely unrealistic way of fixing the global banking system:

    1) Freeze trading in all bank stocks worldwide, then “nationalize” the entire global banking sector overnight (to prevent a run on bank shares and be fair to everyone) – institute “type 4″ FDIC-style conservatorship where a range of agencies pledge to restructure banks along common guidelines, pulling out the nasty assets and getting the fairest deal for shareholders, bondholders and taxpayers in the process, thereby restoring confidence. Governments will probably have to guarantee deposits up to quite a high amount at this stage, globally coordinated so as not to have risk arbitrage occur. No withdrawals above this deposit limit. The G20 sherpas will be exhausted.

    2) We employ an army of morally impeccable (I know) auditors to go through all the world’s banking institutions in super-fast time, assessing value and cleverly netting off any nasty liabilities or assets here between banks and hence hopefully off-setting some loans and reducing leverage that way. The auditors could make a report on the viability each bank using stress tests that constitute optimistic (WSJ) and realistic (Roubini) forecasts. Daily calls between the head auditors of the biggest 20 banks in the world would be needed to coordinate work. Given that all banks are being restructured at once, and all deposit guarantees are the same, people might realize this is just a clean-out of the system and everything will be rebooted to a clean state. All information as it arises is posted on a comprehensive website for everyone to see and track (remember the guarantees and limits!).

    3) When the initial analysis is complete, there is a second round of coordination efforts to decide how best to consolidate both toxic assets and real assets (in the form of infrastructure etc) around the world, to restructure all institutions into the healthiest possible entities. Then, agencies pay out the bondholders in failed institutions as best they can – in some cases perhaps by converting their old debt into new preferred or common convertible equity in entities which will hold the secure assets and operations etc. On re-privatization, the bondholders could exit, and new debt could be raised if required. (I’m wobbly on this point – taxpayers may have to pay-off some bondholders here…)

    4) “Bad” assets will be held collectively in a separate set of funds, owned by relevant taxpayers so they get the upside, should they be worth anything. At some stage, these “bad banks” might be IPO’d too, to pay out taxpayers.

    5) We replace the managers of failed and almost-failed banks with new ones and make them do trust exercises with their subordinates, celebrate moral heroes in banking, and create board-level “head of risk and uncertainty” positions (who immediately initiate a range of scenario planning projects on the future of their banks and ban VAR models from the intranet) etc etc.

    6) Meanwhile, while the banking sector is functioning but in stasis on stock markets, we fast-track new financial regulations. This might include new leverage limits, counter-cyclical reserve requirements and “smart transparancy” – i.e., information flows about potential problems that can detect destructive feedback loops on markets and starts introducing taxes on trades that look speculative or dangerous in terms of contagion. We also agree on macro-prudential rules etc etc. In the spirit of global coordination, and to prevent the kind of financial fragmentation William Buiter points to we might even consider need a global lender of last resort or something (gasp! sovereignty!).

    7) The following morning, with only CR understanding much of what’s going on, markets reopen with many of the old banking stocks delisted, and a few survivors with a clean bill of health. Over the next few weeks, new banking stocks are listed on various exchanges, with many entities already owning stock in by default thanks to the restructuring. With the bad assets gone, values should rise to represent future potential output in the expected economic conditions, and lending should resume among more or less normal lines (although subject to the new regulation).

    8. Heaving a sigh of relief, we suddenly realise that one of the most pernicious aspects of the global financial crisis is over, and rush to the bank to get a home loan, only to find that Buffett already owns the sweetest deals.

    Pros:
    -Complete clean out of all banks at the same time, everywhere
    -Global coordination is built in and assets and liabilities can be consolidated across borders
    -Regulatory uncertainty is removed from financial markets as the market for bank stocks is shut while regulation being prepared
    -Prevents arbitrage between banks, lowers incentives for a run on deposits and removes prospect of a run on bank stocks
    -May turn up more fragile institutions sooner rather than later
    -Creates lots of jobs for auditors and accountants
    -others??

    Cons:
    -It is completely impossible to execute because of:
    –political objection to cost and ideology of wholesale nationalization
    –national interests and time required to coordinate
    –scale of auditing and conservatorship required, lack of talent
    –differing capacities in different countries/states
    -Could cause severe damage to financial markets unless this can literally be done overnight
    -would threaten national sovereignty for many countries
    -there are a number of massive mistakes in the analysis above
    -others??

  30. Kind of what FDR did, then? Only do it global?

    He declared a bank holiday, closing them all. Then they assessed them all, and opened them only when they’d passed muster. Many banks never were allowed to re-open.

    See Why Did FDR’s Bank Holiday Succeed? at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1013606 for a summary.

    That time, it was individual depositors who needed to have confidence in the banks. FDR’s actions and his fireside chats convinced enough people that people were actually lined up to deposit money when the banks did re-open.

    This time it is basically investors and other banks that have to regain confidence in each particular bank. Because of the FDIC, the individuals aren’t having a confidence problem about their money.

    But why not do it worldwide? It would be better than sitting on their hands. (So many people in the U.S. aren’t realizing that the situation is worse outside the U.S., almost everywhere.) Political considerations may be outweighed by economic ones – but I doubt it. It won’t happen, but maybe it should…

    Woulda should coulda. . .

    After this is all over, the historians and economists will have a field day, analyzing it all and telling us what happened and what should have happened. For decades. But right now that is in the far future…

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  32. What happened to the idea for a bad bank to take all the toxic assets and hold them in one nationalized portfolio?

    Interesting to note that some of the former execs from failed mortgage giants have been making big money buying mortgages, at say 10 cents on the dollar and then selling for more.

    A localized business centric approach seems to be needed on a national scale.

  33. Thanks for the link, Steve. Here’s FDR (quoted by Dani Rodrik here):

    The country needs and, unless I mistake its temper, the country demands bold, persistent experimentation. It is common sense to take a method and try it: If it fails, admit it frankly and try another. But above all, try something. The millions who are in want will not stand by silently forever while the things to satisfy their needs are within easy reach.

    Are we seeing bold, persistent experimentation by governments yet?

  34. Pingback: Nationalization for Beginners « The Baseline Scenario « US Economic Views

  35. If there are $2 trillion in writedowns coming, then taking over the banks would cost $2 trillion, less the value of equity, less any liabilities the government is going to either convert to equity or stiff altogether. Whether to do the latter and how much of it to do I can’t say at this point, partly because I haven’t thought about it a lot, mainly because I think you need inside regulatory information (you need to know who is getting stiffed and how much damage it will cause). It would cost that much because in order to re-privatize the bank, you have to fill the balance sheet hole caused by those asset writedowns.

    Now, one argument for biting the bullet and doing it is that the longer you wait, the worse those assets become, and the bigger the hole becomes.

  36. That’s a good point. I admit that I said roughly the same thing that Geithner did.

    I think that decisions about how to allocate capital and what risks to take (and what risks to pass on) are best made by people trying to make money. At one extreme, I think that venture capital funding is best provided by the private sector, because you want a strong profit motive determining who gets capital. However, I am open to the idea that maybe deposit-taking and checking services could be a government service. I admit, I’ve never really thought about it much. Maybe you could have government institutions that did routine banking functions. (You would lose some of the benefits of competition, like higher CD rates for consumers – but maybe we could do without that.) But then you would somehow want to funnel the money to private sector banks that made riskier allocation decisions. It seems to me you have to worry about political influence (and the kind of bad decisions that come with not caring about the outcome) in the step where the money moves from the government to the private sector. If you can’t solve that problem, then it’s best to leave the money in the private sector the whole time.

  37. How much inflation? A few months ago, Simon was saying the same thing: given that inflation expectations then were negative, we needed Bernanke to pump them back up. Now, however, I believe inflation expectations are up around 2% again. I have heard people say that we should increase inflation expectations to around 5%.

  38. There is letting them fail and then there is really letting them fail. Sweden actually issued a blanket government guarantee on all bank liabilities. That protected the system from domino effects. We could theoretically do the same thing, but it would bump up the national debt a lot.

    The other way to let them fail is to take them over and not honor the debts. That would be like a traditional bankruptcy – the creditors may be paid back, but they may not. That is where the domino effects come in.

    The former is safe but very expensive. The latter is cheaper but risky.

  39. Pingback: links for 2009-03-10 at DeStructUred Blog

  40. One thing that continues to puzzle me is the absence of discussion on this and other blogs regarding realistic explanations for the Administration’s apparent stubborn resistance to nationalization. I use the word realistic because, as a strong Obama supporter, I refuse to believe the common claim that he and his advisors are blindly in the pocket of Wall Street bankers and their lobby….or that these people are captives of some stereotyped ideological notion of “nationalization” or even “socialism.” I really wish some of the smart economists who contribute to the blog would address this seriously, and play a “devil’s advocate” role so that we might better understand the policy obstacles that exist. A good starting point might be to consider the work of David M. Smick, whose opinion piece in today’s Washington Post made the claim that Geithner, et. al are terrified that nationalization would trigger multi-trillion dollar panics involving credit default swaps. While I’m not qualified to render judgement on this idea, I am somewhat heartened that someone is taking their criticism of the Obama inaction a few steps beyond the near-whining repetition I’ve been reading on these pages recently.

  41. 5% would be just great. 5% nominal GDP growth. That is the Feds standard target. Just have the hit it!

    More inflation than expected. It is not really about inflation – it is about inflationary expectations – to get people to spend – to change their behavior – and their attitudes.

    The change in expectations in the tips market is not what I have in mind. We need a statement from the Fed – a public commitment to a price level target – a promise that prices will be x higher in y years. That promise, if believed, will get people to spend more now – before their cash in the bank erodes. Changes in rate expectations are not powerful enough – because they could also change back – and might – and we all know it. A commitment is very different – because we all know the Fed can make that happen – whatever expectations are. Therefore it will be believed. And behavior will change. Houses, cars, and stocks will be bought. The action will move from the bid side to the asked side. Real wages will fall and employment will rise.

    The Fed has lost control of the money supply – and of monetary policy. No one believes them. Bernanke is passive – sitting in Congress and saying that he EXPECTS – economic activity to be slower for a year or two. That was entirely and utterly dreadful – the thinking of a passive bureaucrat – not of a leader – not of a Volcker. It is Bernankes job to CAUSE things to happen. It is our job to expect them.

    Summers has said that the government should now do “too much” – because the economy is doing to little. But the Obama administration is not doing too much – it is doing too little – about the immediate financial crisis – and his nice indeas amout stem cells or Iran or environment – who could possibly care less if we have a depression. People are really starting to wonder what plant he is living on.

    The stock market in the last two months has had the worst two months in the entire history of the stock market. People should really really think about that. It both reflects and causes the most profound kind of deflationary fears. The worst two months ever – ever – ever. That is really not good. And the dollar is climbing. Both of those things both reflect and cause deflation. Straight panic is right round the corner. And Obama dozes. And reminds us how politically correct and wonderful he is. When I see him on tv now I turn it off and gag. I voted for him – but his budget is a lie from end to end – and he knows it – and so do I. That is really not good. If he is not careful he literally will be the next Hoover. His chance to be the next Roosevelt is already shot.

    Which is why people are so entirely freaked out. By this time in his administration FDR had prices rising and production making a big time come back – by going off gold and giving us an unexpected inflation. And the banks were in worse shape then than they are now.

    Why has Bernanke not done this? He is fully and entirely aware of everything I have said. He is not an Andrew Mellon – a conscious deflationist (though there sure are plenty of these on the web). But Bernanke is giving us deflation. His policies are NOT WORKING. Does he not notice this? By the Taylor rule – which he is entirely and totally aware of – short rates now should be at minus six percent. Money is greeting tighter and tighter and tighter, as prices fall and fall. It is entirely and totally insane. And he sits there and does nothing. Why?

    Because he is a frightened little mouse of a man. Because he does not have the votes on the board to do this. Either it is this or he really has gone insane.

    He needs political cover from Obama. To aim consciously at deflation is not a normal policy – to say the least. Obama should say that an inflation is what he wants – and then direct the Fed to get one. That would give Bernanke the cover he needs. And that would be the decisive “too much” policy that Obama needs. Then he can give a many speeches on stem cells as he wants – though I still won’t listen to them.

    And – I think – toss out Geithner and replace him with Volcker. Nixon goes to Chine. People will trust Volcker to give us a moderate and careful inflation.

    And then – the very next day – right after the speech – recap the banks.

  42. This is also posted above – in reply to a reply to an earlier post I made -but I wanted to be sure everyone saw it and so am also posting it at the end – cause I am an egomaniac –

    On inflation – 5% nominal GDP growth would be just fine. That is the Feds standard target. Just have the hit it!

    More inflation than expected. It is not really about inflation – it is about inflationary expectations – to get people to spend – to change their behavior – and their attitudes.

    The change in expectations in the tips market is not what I have in mind. We need a statement from the Fed – a public commitment to a price level target – a promise that prices will be x higher in y years. That promise, if believed, will get people to spend more now – before their cash in the bank erodes. Changes in rate expectations are not powerful enough – because they could also change back – and might – and we all know it. A commitment is very different – because we all know the Fed can make that happen – whatever expectations are. Therefore it will be believed. And behavior will change. Houses, cars, and stocks will be bought. The action will move from the bid side to the asked side. Real wages will fall and employment will rise.

    The Fed has lost control of the money supply – and of monetary policy. No one believes them. Bernanke is passive – sitting in Congress and saying that he EXPECTS – economic activity to be slower for a year or two. That was entirely and utterly dreadful – the thinking of a passive bureaucrat – not of a leader – not of a Volcker. It is Bernankes job to CAUSE things to happen. It is our job to expect them.

    Summers has said that the government should now do “too much” – because the economy is doing to little. But the Obama administration is not doing too much – it is doing too little – about the immediate financial crisis – and his nice indeas amout stem cells or Iran or environment – who could possibly care less if we have a depression. People are really starting to wonder what plant he is living on.

    The stock market in the last two months has had the worst two months in the entire history of the stock market. People should really really think about that. It both reflects and causes the most profound kind of deflationary fears. The worst two months ever – ever – ever. That is really not good. And the dollar is climbing. Both of those things both reflect and cause deflation. Straight panic is right round the corner. And Obama dozes. And reminds us how politically correct and wonderful he is. When I see him on tv now I turn it off and gag. I voted for him – but his budget is a lie from end to end – and he knows it – and so do I. That is really not good. If he is not careful he literally will be the next Hoover. His chance to be the next Roosevelt is already shot.

    Which is why people are so entirely freaked out. By this time in his administration FDR had prices rising and production making a big time come back – by going off gold and giving us an unexpected inflation. And the banks were in worse shape then than they are now.

    Why has Bernanke not done this? He is fully and entirely aware of everything I have said. He is not an Andrew Mellon – a conscious deflationist (though there sure are plenty of these on the web). But Bernanke is giving us deflation. His policies are NOT WORKING. Does he not notice this? By the Taylor rule – which he is entirely and totally aware of – short rates now should be at minus six percent. Money is greeting tighter and tighter and tighter, as prices fall and fall. It is entirely and totally insane. And he sits there and does nothing. Why?

    Because he is a frightened little mouse of a man. Because he does not have the votes on the board to do this. Either it is this or he really has gone insane.

    He needs political cover from Obama. To aim consciously at inflation is not a normal policy – to say the least. Obama should say that an inflation is what he wants – and then direct the Fed to get one. That would give Bernanke the cover he needs. And that would be the decisive “too much” policy that Obama needs. Then he can give a many speeches on stem cells as he wants – though I still won’t listen to them.

    And – I think – toss out Geithner and replace him with Volcker. Nixon goes to China. People will trust Volcker to give us a moderate and careful inflation.

    And then – the very next day – right after the speech – recap the banks.

  43. This is for JimP, but I don’t get a link, for some reason…

    Jim, you say, “We need a statement from the Fed – a public commitment to a price level target – a promise that prices will be x higher in y years. That promise, if believed, will get people to spend more now – before their cash in the bank erodes.”

    Why do you think that? Not that we can take a Gallup poll at face value these days, but the Gallup-Healthways Well-Being Index from USA Today (03-10-09) says that 62% of us – 5 out of 8 – are “struggling or suffering.” What I am seeing and hearing around Illinois does lead me to think they are close to the mark. People right now aren’t worried about maybe losing a little value to inflation. They are more worried whether there will be food on the table in 3, 6 0r 12 months. A LOT more worried. No one is planning vacations this year AT ALL. Everyone is hunkering down. Worrying about losing a few percentage points to inflation – if inflation is even happening – is such a ‘pre-Depression’ mentality, something from long ago, like late 2007.

    Mark Weisbrot points out that, “But inflation is falling in most of the world, and in the US, prices are actually dropping. The US consumer price index fell at an annual rate of 8.4 percent over the last quarter.” (http://www.truthout.org/030609J)

    It seems we are going to NEED all that government money in the economy, just to balance out the deflationary spiral that is trying to take hold. As I learned it, in the 1930-1935 period the money supply dropped by a third.

  44. Bernanke believes that the bust of ’29 became the deflation from hell because (1)the Fed did not act to increase liquidity and (2)it permitted banks to fail in accordance with laissez-faire ideology.

    He’s not repeating the mistakes of the past and is dong just the opposite: driving interest rates to zero and bailing out the too-big-to-fail banks.

    He’s so confident he’s learned the lessons of history that he anticipates economic recovery in ’10. (Bernanke addressing the CFR, 3.10.09)

    On the other hand he admits that the “powerful and pervasive effects of financial market failures” nearly took his breath away. He did not anticipate the magnitude of what happened…like Greenspan asleep at the wheel…but he is fully convinced that the TARP bailout was the best move to make. He believes deep in his bones that “stabilizing the financial markets” is the priority and the key to recovery.

    The stimulus may be important, and he won’t speak to the decisions of Congress, but bailing out the banks to fend off systemic failure is the sine quo non. Furthermore, financial stability will not be achieved thru nationalization. He doesn’t believe in changing horses in mid-stream, which could only increase systemic instability.

    He’s fully committed to putting Humpty Dumpty together again, with a new regulatory regime involving an uber-agency called the “systemic risk authority” and increased transparency and accountability in all the markets, especially in the new derivatives market, the new domain of “financial economics”. “Illiquid or idiosyncratic assets”, as he calls them, the financial innovations arising from this new school of “financial economics” have to be better integrated with the more “mature” instruments and appropriately regulated to inspire investor confidence.

    Our future is riding on his analysis of economic history and his belief in the priority of financial markets. It is for this reason that our future is very grim indeed. It is very easy to speak of the future since it hasn’t happened yet, whereas one can footnote statements about the past.

    The past is prelude and the past demonstrate the failure of finance, whether through the national banking infrastructure of the past, or in the concentration of financial wisdom and control that is our Federal Reserve in the present.Finance does not manage the economy very well at all. The Fed has failed in its mandate to maintain stability and lessen the impact of the so-called “business cycle”. This crisis is the most spectacular to date.

    We are witnessing the failure of the latest financial innovation inspired by the work of Myron Scholes & Robert Merton and the school of “financial economics” itself. It is a colossal bust. Securitization, derivatives trading, it’s all a smoking heap of econometric delusion.

    Nationalization is inevitable. Get ready for something that is not taught in schools. Throw out your tired old text books, including your Adam Smith! Private capital has failed to manage its private financial system. Is there any dispute about this? Do the banks and brokerages showing up at the government doorstep, hat in hand, palms outstretched, speak of the success of private finance? That is why we will have a public system.

    But Bernanke will do his utmost to get the wreck up and running again in the name of the class interest he represents, his friends at the Council on Foreign Relations and other elite enclaves. And everyone else will suffer, the great mass of people bamboozled by the economic bs promoted on this website and so many others, and those who follow the pied pipers of finance as well.

    The cause of the crisis is not difficult to understand, though Benanke doesn’t get it, as no financier does. The cart does not pull the horse. The horse pulls the cart and the horse in the producer, not the financier. The financier is a parasite who rides in the cart.

    Go figure.

  45. Thanks, James. I am trying, in my ‘beginner’ way, to ask intelligent questions. From your reply I understand I succeeded at least once.

    If Citi is down 99%, isn’t everyone already panicked and already beginning to see where they will be if that last 1% goes?

    (I THINK the answer to that is that, even though the stock price is down 99%, Citi’s value is not really that low. I would guesstimate their overall net worth at about 40-60% of what they were in late 2007. That would put their stock price as one of the all-time great values right now. But the risk, I suppose, is keeping investors away – for the moment.)

  46. Marxist twaddle. And deflationary – of course.

    The line of the Communist Party of Germany when they backed Hitler – the worse it is the better it will be.

    First the deflation and then the revolution.

  47. An online translator gives this translation of your post:
    “Anyway, it is very not much probable that fountain of stimulus reveals the world-wide economy for the growth, or pressure in the prices, in the near months. The American economists seem more and more convinced than the packet of stimulus recently approved by the American Congress will be insufficient before the scale of the current recession, and the idea of more increases of expenses does not seem politically palatable at the moment. Many highly thought of economists believe that the government Obama is skating, it wasting time with shy proposals of recuperation of the banks, when the only real exit would be his nationalization.”

    My son has a degree in Economics, and the economists he pays attention to – Krugman, Stiglitz, Weisbrot, Dean Baker – seem to agree. Two of those are over my head, but what I understand of the other two, I agree, too.

  48. Response to Nicholas Davis (no link for replying to his…):

    FDR had 5 months between his election and his inauguration, and the Depression had already been going on for 3 years and 5 months.

    Obama’s crash came 7 weeks before his election, and he had 11 WEEKS from his election to his inauguration.

    FDR’s bank holiday was declared March 5th, the day after he took office. Obama has just passed March 5th. FDR’s 100 days ended when? Around June 13th?

    FDR had lived through part of the Long Depression, and also the one about 1907, and so did all of his advisors.

    We may be being unfair to Obama. Not Obama nor his advisors has ever lived through a real depression. Maybe we should be giving him some leeway, letting them take some time to assess the decisions we are asking them to make.

    I’ll tell you what, that 3 years of Depression that FDR had must have been part of the reason that the bank holiday was ready to go on Inauguration Day. He and his advisors had certainly seen what DIDN’T work. They had Hoover to show them the path to not take. For 3 freaking years.

    One might also say that June 13th would be his equivalent time (from election day) to FDR’s 100 Days. We may not last that long, but. . .

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  50. Is there a sixth way to nationalise a bank? Set up a sovereign wealth fund with (say) Paul Volcker appointed to run it, with instructions to (a) acquire any bank that Mr Volcker chooses to invest in, (b) replace the management of the bank, and (c) sell its investments within the next (say) 15 years. US Treasury could also announce that government support will be limited to only banks that are (say) at least 80% owned by the sovereign wealth fund.

    It seems to me that this approach gives US taxpayers the potential upside to giving government support to a bank, and also maintaining an arms length relationship between the government and the bank, with the SWF in between.

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