Hank Paulson’s testimony yesterday was informative, if only because it illustrated that he himself still understands little about the origins and nature of the global crisis over which he presided. Perhaps his book, out this fall, will redeem his reputation.
A fundamental principle in any emerging market crisis is that not all of the oligarchs can be saved. There is an adding up constraint – the state cannot access enough resources to bail out all the big players.
The people who control the state can decide who is out of business and who stays in, but this is never an overnight decision written on a single piece of paper. Instead, there is a process – and a struggle by competing oligarchs – to influence, persuade, or in some way push the “policymakers” towards the view:
- My private firm must be saved, for the good of the country.
- It must remain private, otherwise this will prevent an economic recovery.
- I should be allowed to acquire other assets, opportunities, or simply market share, as a way to speed recovery for the nation.
Who won this argument in the US and on what basis? And have the winners perhaps done a bit too well – thinking just about their own political futures?
Back when I had time to read The New Yorker, I was a big fan of James Surowiecki. I would always look for his column; if it was there, it was usually the first thing I would read. Unfortunately, he’s no fan of mine.
Surowiecki makes three points about our recent long post on nationalization:
- If the government were to take over a large bank like Citigroup, it would not be able to sell it into the private sector quickly, but would most likely own it for several years, which constitutes nationalization.
- Recent U.S. history, by which he means the S&L crisis, shows that the right strategy is “exercising regulatory forebearance, cutting interest rates sharply (which raises bank profit margins), and helping the banks deal with their bad assets” – not bank takeovers.
- We were misleading in citing the IMF’s $4.1 trillion number instead of the lower $1.1 trillion number for U.S. financial institutions. “I assume they used the $4.1 trillion number because it’s much scarier, and offers a much gloomier picture of the state of the U.S. financial system. Unfortunately, it also offers a much more misleading picture of the system.”
Sigh. I guess it’s impossible to make everyone like me.
I’ll take the points in reverse order.
Writing in the Financial Times on January 27th, 2009, Peter Boone and I expressed our opposition to bank nationalization in no uncertain terms,
If you want to end up with the economy of Pakistan, the politics of Ukraine, and the inflation rate of Zimbabwe, bank nationalization is the way to go.
Most others who recently advocated a managed bankruptcy process – or FDIC-type intervention – for big banks (with or without the injection of new government capital) were careful, at least initially, to avoid using the word nationalization. And many took pains to explain in detail why their proposals were quite different from nationalization.
But at some point this became a debate in which informed bystanders perceived the sides as being for or against “nationalization” - a semiotic transition that has obviously helped the big bankers, at least in the short term.
This weekend’s comment competition is in two parts. Who first made “nationalization” the central word for the U.S. bank discussion? And who was most influential in establishing that the national debate be defined in these terms?
Regular readers will know that we are fans of Thomas Hoenig, president of the Kansas City Fed (see here). I was catching up on the week’s news via Calculated Risk and came across Hoenig’s recent op-ed in the Financial Times, which I recommend as a follow-up to (or shorter version of) our previous post. Nor surprisingly, Hoenig argues that large bank holding companies should be allowed to fail, meaning:
Non-viable institutions would be allowed to fail and be placed into a negotiated conservatorship or a bridge institution, with the bad assets liquidated while the remainder of the firm is operated under new management and re-privatised as soon as is feasible.
Hoenig provides a list of arguments in support of this position. He starts with moral hazard, which would not have been at the top of my list. But I particularly like these:
So-called “too big to fail” firms have been given a competitive advantage and, rather than being held accountable for their actions, they have actually been subsidised in becoming more economically and politically powerful.
As these institutions are under repair, the Federal Reserve is making loans directly to specific sectors of the economy, causing the Fed to allocate credit and take on a fiscal as well as a monetary policy role.
A systematic approach would reduce the uncertainty that has paralysed financial markets; the cost is more measurable and therefre manageable.
Here’s a link to the whole thing again.
By James Kwak
The post was co-authored by Simon Johnson and James Kwak.
When the stress tests were first announced on February 10, bank stocks went into a slide (the S&P 500 Financial Sector Index fell from 133.13 on February 9 to 96.18 two weeks later), in part on fears that the stress tests would be a prelude to “nationalization” of the banks. This week, it has emerged that several large banks will require tens of billions of dollars of new capital, most notably Bank of America. They could obtain that capital by exchanging common shares for the preferred shares that Treasury now holds, an accounting trick that boosts tangible common equity without providing the banks any new cash. Such a conversion would greatly increase the government’s stake in certain banks, perhaps even above the 50% level, yet the markets seem relatively unconcerned this week, with the S&P 500 Financial Sector Index at 168.14 and rising.
Back in February, America was mired in a public debate over the word “nationalization” and what it meant for our banking system, with contributions by Nobel Laureates Paul Krugman and Joseph Stiglitz, former and current Fed officials Alan Greenspan, Alan Blinder, and Thomas Hoenig, and administration figures Timothy Geithner, Larry Summers, and even Barack (“Sweden had like five banks“) Obama, among others. On a substantive level, the debate was over whether large and arguably insolvent banks should be allowed to fail and go into government conservatorship, as happens routinely with small insolvent banks. Opponents of this view who wanted to keep the banks afloat in their current form, including the current administration, beat off this challenge by calling it nationalization (more precisely, by demonizing government control of banks). Perversely, however, what we got instead was increasing co-dependency between the government and the large banks, as well as increasing influence of the government over the banks, and vice-versa. And according to the market, the banks should be quite happy with this outcome.
One of the determinants of how you feel about the Geithner Plan is what you think will happen if it fails. By “fails,” I mean that the buyers’ bids are lower than the sellers’ reserve prices, so the toxic assets don’t actually get sold.
Brad Delong, for example, is moderately in favor of the plan, even though he thinks it is insufficient. In his words, “I think Obama has to demonstrate that he has exhausted all other options before he has a prayer of getting Voinovich to vote to close debate on a bank nationalization bill. Paul [Krugman] thinks that the longer Obama delays proposing bank nationalization the lower it’s chances become.” (“Voinovich” is DeLong’s hypothetical 60th senator, whose vote would be needed in the Senate.) In other words, DeLong thinks that if this plan fails, the administration will be more likely and able to go forward with nationalization.
Paul Krugman, by contrast, is strongly against the plan, first because he thinks it has no chance of succeeding, and second because he thinks there is no Plan B. “I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second.”
The more aggressive the government’s responses to the economic crisis become, the more likely that they will end up in the courts. Changes in regulation can be interpreted as constraints on the ownership of property – especially by the people who own that property – and therefore such changes have occasionally ended up in the Supreme Court. The article below is by Ilya Podolyako, a third-year student at the Yale Law School and the co-chair (with me) of a reading group on law, economic policy, and the economic crisis.
As the New York Times reported today, Geithner and Bernanke were on Capitol Hill to ask for greater power to wind down non-bank financial entities like AIG. During the hearing:
[Representative Barney] Frank said the different fates of Lehman Brothers and A.I.G. illustrate the need for options beyond the “all or nothing” approach. “One was the Lehman Brothers example, where they were allowed totally to fail and there was no help to any of the creditors,” Mr. Frank said. “The other is the A.I.G. example, where there was help for all of the creditors. Neither one is what we should be doing going forward.”‘
Geithner and Bernanke largely concurred. Basically, the key actors want to be able to apply a receivership/conservatorship-type system that currently covers members of the FDIC, Savings and Loan institutions, and Fannie/Freddie to any entity whose financial activity poses a systemic risk to the economy.
James has pointed out that proponents of nationalization for Citigroup and Bank of America have essentially the same thing in mind: have the government take over an entity, preserve the rights of depositors, and sort out which liabilities deserve payment and which do not. Baseline Scenario has consistently and persuasively argued that such an approach would be prudent. Indeed, it would avoid the awkward political fallout of the type that arose when AIG disclosed that $60+ billion worth of federal aid went directly to its various derivatives counterparties. The problem is, this policy might not be constitutional.