Now that it is increasingly clear that the biggest question we face is not whether to nationalize some of our biggest banks but simply when and how we do it, we need to start paying more attention to the risks and costs of nationalization. It’s vitally important that we get this right.
Here’s Tyler Cowen on why our nationalization will be a lot of tougher than Sweden’s:
Many analysts cite Swedish bank nationalization, from the early 1990s, as a model, because the Swedes later reprivatized these banks and resumed economic growth.
But Sweden nationalized only two banks. And the Swedish banks were much smaller and easier to run than the largest United States bank holding companies, which combine a wide range of complex international businesses, commercial paper operations, derivatives trading and counterparty commitments.
It is quite possible that the reputation of a nationalized bank would be so impaired that it would incur even greater losses as its web of commercial dealings collapsed. These far-reaching commitments are a reason that the F.D.I.C. model of rapid shutdowns cannot be applied so easily here.
The most obvious problem with nationalization is the risk of contagion. If the government wipes out equity holders at some banks, why would investors want to put money into healthier but still marginal institutions? A small number of planned nationalizations could thus lead to a much larger number of undesired nationalizations.
On top of that, the government doesn’t have the expertise to run large bank holding companies like Citigroup. There is the danger that caretaker managers, with bureaucratic incentives, will never return the banks to profitability. And restrictions on executive pay, already enacted into law, will make it hard to hire the necessary talent.
In the meantime, there would be increasing pressure to politicize lending decisions — for instance, by requiring loans to the ailing automobile industry. Talk of taxpayers capturing an “upside” is probably unrealistic.
The plight of the American International Group, the giant insurer, provides a cautionary tale. The government has already effectively nationalized A.I.G., but after a government commitment of $150 billion, the company’s losses continue to mount, and there is no simple way to either manage it or split it up. If the government cannot run that bailout very well, how can it run major banks and nurse them back to profitability?
Nationalization also puts bank debts on the balance sheet of the government without restoring bank solvency. Once the government takes over, it is hard to reorganize the debts of these companies without damaging the government’s own creditworthiness and spreading the insolvency to bank creditors. Yet if the banks are insolvent, paying off the creditors may cost trillions.
It’s easy to call for “transparency” in a banking plan — as is the ostensible goal behind Mr. Geithner’s “stress tests” of the big banks. But transparency isn’t a simple concept, especially in hard times with poorly functioning asset markets and uncertain valuations.
For instance, standards for bank solvency depend on whether the government applies a “mark to market” standard to bank assets. If the long-run value of a mortgage security exceeds what it would fetch on the open market today, what is the security’s “transparent value,” and which figure should the government use in deciding whether to shutter or nationalize a bank?
There is not always a clear line separating solvent and insolvent banks. In many cases, the government would simply be choosing which banks deserve to survive.
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