I am going to try and keep this as short as possible because I’m off on a biz trip tomorrow (expect a lot less blog activity from me for about a week) and have things I need to get done before then.
But I just had to comment on the statement released jointly this afternoon by the Treasury, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), and the Fed.
In the statement, which discusses the upcoming ‘stress test’ process all large banks will be undergoing starting Wednesday, the government in essence reaffirmed its preference that the banking system remain in private hands, saying in part:
“Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands.”
For the past several weeks, I have maintained that we need to address our financial crisis in a significant and comprehensive way if we expect the other aspects of our recovery plan, such as our stimulus package, to have any kind of lasting impact.
I have argued that the banking system is so poorly capitalized that we will eventually need to nationalize significant swaths of our banking system, and that I’d rather get there sooner than later before we throw away hundreds of billions of dollars trying to put band-aids on a mortal wound.
I have heard several objections to the idea of nationalizing our banking system over the past several weeks. I will go through them quickly.
1) Do you really expect the government to run a bank effectively?
No, I don’t. And the mandate will have to be for the government to clean up any nationalized institution and get it back into private hands as quickly as possible (though perhaps in a different, less unwieldy form, i.e. turning a conglomerate like BofA into a bunch of smaller institutions based on region or function).
However, it’s not like we’re going to be putting lifelong bureaucrats and politicians in charge of running the day-to-day operations of nationalized institutions. Except for maybe the top tier of management, the vast majority of bank personnel would remain in their current positions, and I assume that respected, qualified individuals who have always worked in finance would make most of the major decisions.
More importantly, I find it deliciously ironic when people pursue this line of argument, because as bad as government will likely be at running banks, how can they possibly do any worse than our vaunted private system, which obviously got us into the current mess in the first place.
2) Nationalizing the banks will throw the system into chaos.
The system is already in chaos. The question is would nationalization cause the kind of systemic collapse that some people argued almost happened when Lehman Bros. was allowed to fail. Opponents fear a situation where all lending would shut down and people would start running to their banks to pull out money, creating a financial panic that we’ve largely avoided so far.
I don’t think this would happen at all. Perhaps the automobile manufacturers can make a rational case that if they were forced to declare bankruptcy, consumers would be much less likely to buy their cars because of concerns about car quality, or warranties being honored. But I think if anything, when it comes to their finances, consumers would feel more confident knowing their money was in the hands of the government. Corporations and other healthier banks I think would also perhaps be more willing to do business with nationalized institutions.
After all, this would be a nationalization, not a bankruptcy where assets would have to be sold immediately and at any price; once the uncertainty of the banks’ survival was removed, the government could take its time in figuring out the best way to handle the toxic asset situation and eventual reprivatization process.
3) Nationalization would call into question the very essence of our capitalist system.
I think this could happen. Confidence in the integrity of the system is a key prerequisite for a healthy, functioning capitalist economy. It’s why large and widespread examples of fraud and abuse, like we’ve seen with Enron and Madoff, create so much long-term damage.
Equity and especially bond holders who see their investments, contracts and covenants basically voided by the federal government would no doubt wonder about the very essence of private markets and private property, and whether they could feel confident that they truly owned any of their other investments.
However, I think we can mitigate these concerns by structuring the process and the language we use to make it clear that any nationalization plan would be both limited in scope and temporary in nature.
Unfortunately, we are facing an emergency situation and extreme measures are sometimes needed at those times. We can deal with the economic philosophizing later.
There are other arguments people have made against nationalization. Some argue that while nationalization may have worked for Sweden and Norway, it will be too expensive here. Others say that if we just tried to value these toxic assets accurately and dropped arcane accounting techniques like mark-to-market, nationalization wouldn’t even be necessary.
I think the critics of nationalization are all swimming in denial. Nationalization won’t be easy and painless. Mistakes will undoubtedly be made throughout the process. Certain investors would obviously lose everything. It’s merely the best of a bunch of bad choices. And whether we like it or not, it’s already happening: We already have basically nationalized Fannie Mae and Freddie Mac and AIG, and could own 40% of Citigroup if a current capital infusion plan being negotiated is implemented.
The question is whether we continue to engage in a form of Chinese water torture by trying to fix the situation in a piecemeal, haphazard manner or finally come to grips with the magnitude of our current crisis by devising a plan that deals with the situation once and for all.