Stop Rearranging Deck Chairs on the Titanic and Nationalize the Damn Banks
By Joshua Holland, AlterNet
IT'S THE BEST POSSIBLE course to rescue our economy at this point; all
the other options would be disastrous.
The painful but unavoidable reality of the financial crisis is that
every dollar spent trying to prop up a failing bank is just good money
thrown after bad; a taxpayer rip-off, short and sweet.
But in Washington, many are trying to avoid that fact nonetheless.
Economist Paul Krugman wrote that the political establishment has
"become devotees of a new kind of voodoo [economics]: the belief that
by performing elaborate financial rituals we can keep dead banks
walking." Goldman Sachs' economists estimate that those rituals might
cost up to $4 trillion to perform.
It's time that the government stops flailing around with piecemeal
bailouts and loan guarantees, takes over these institutions -- takes
them out of private ownership -- sells off their good assets in an
orderly way, trashes the toxic stuff and then resells them to the
private sector down the road as leaner institutions that are dedicated
to the primary purpose of banking: making loans and holding deposits.
In economic circles, that's the "N-word" -- it isn't a racial epithet,
it's "nationalization," and it was unheard of in mainstream discourse
just a few short months ago. But it's remarkable how a crisis as deep
as the one we face today can change which ideas are considered
In a way, nationalization is the approach that most closely adheres to
"free market" principles, which dictate that poorly managed firms
should go under, freeing up their human and other capital to be
absorbed by well-managed businesses.
Sometimes, the market works. Wall Street's titans lobbied like hell to
get regulators off their backs, they figured out elaborate ways to
"launder the risk" out of high-risk debt, and then they engaged in a
furious push to get lenders to make more and ever-shakier loans -- the
raw materials of those "innovative investment vehicles" that are now
known as "toxic securities."
They did that based on an entirely irrational idea that the housing
market would continue to grow dramatically forever, and they did it
while ignoring voices of sanity which warned that they were steering
those fancy "investment vehicles" right off a cliff. Now, many are
teetering on the brink of collapse, and classical economic theory says
they should crash and burn.
But with financial giants like Citi or AIG, the common argument
against that course is that regardless of their complicity in creating
the global economic meltdown, they're simply "too big to fail" because
their collapse would have a ripple effect through the economy.
This is probably accurate; a sudden crash of an institution with
hundreds of billions of dollars -- or even trillions -- on its balance
sheets would have far-reaching effects. When Lehman Brothers went
belly-up last fall, it came close to bringing down the entire global
financial system with it.
But a major problem with all of the approaches tried so far -- and
those being discussed in connection with the future of the dubious
Troubled Assets Relief Program -- is they're all premised on the idea
that these faltering institutions can, and should be propped up and
remain in the private sector. Their investors' stakes, while worth a
fraction of what they were a year ago, are being protected (and many
ailing institutions are still paying out dividends).
And while Capitol Hill has been flush with largely symbolic gestures
to cap executive pay or limit the shininess of management's golden
parachutes, most of the people who ran these institutions into the
ground -- as well as the global economy as a whole -- are holding onto
their cushy jobs.
Nationalization is a radical move, but there are real and practical
problems with trying to prop up falling banks that are fundamentally
unsound. So far, several broad approaches have been bandied about in
D.C. All have similar flaws, and all represent an elaborate dance
around the N-word.
The first is to buy up the banks' toxic assets -- the original concept
behind the TARP. The government would fund the creation of a "bad
bank" to hold onto those assets in the hope that they would increase
in value down the road and maybe return some cash to the taxpayers.
The argument is that the government can buy and hold that junk with
money the private sector can't raise, and also pays less for the cash
in the first place.
But there's a big problem with the idea of creating a "bad bank."
Asset prices are so low right now that either the government overpays
for them, providing a huge subsidy to shareholders in companies that
are on the shakiest of ground, or it pays a fair value for those
assets, in which case banks holding large amounts of debt-based
securities would have little incentive to participate. If they did,
they'd go belly-up anyway (if they could simply sell off their crappy
paper at current prices -- however one determines what those prices
are in a market that's essentially shut down -- we wouldn't be in this
Another proposal -- one that has gained currency since the first round
of TARP money was dished out -- is to "recapitalize the banks" by
buying stock in the firms. The government would basically become an
investor, and assuming that the institutions in question rebounded, it
could later sell its shares and recoup some or all of the dollars
taxpayers threw at them.
Here, there's a similar problem. The value of bank stocks are at rock
bottom, and there's a reason for that: they represent a terrible
investment, and that would effectively make the U.S. taxpayer the
sucker of last resort -- a chump who would buy into a failing
Yes, it's possible that somewhere down the road, these banks would
return to health, but it's important to recall that the financial
sector has become bloated with excess capacity, so that outcome is
anything but guaranteed, and at the very least would take years to
The U.S. government has already taken this approach, "partially
nationalizing" several banks. But when the feds only go partway, we
get ripped off. In the case of Bank of America and Citigroup, the Fed
pumped more money into those banks than their entire market value, and
in exchange taxpayers got a 6 percent stake in BofA and 7.8 percent of
Citi. As econ-blogger Barry Ritholtz noted: "How 120 [percent] of a
company's market [value] yields a single-digit ownership stake is
beyond my comprehension."
Perhaps the biggest problem with this approach is that while the
public gets a stake in the banks' future, so far it's given the
government little or no say over how the banks do business while they
enjoy the public's largesse. Banks are reportedly hoarding money to
beef up their balance sheets, using TARP funds to pay out dividends
and bonuses, or buying up smaller, sicker institutions.
There's plenty of talk in Congress about requiring greater
transparency of firms receiving TARP funds -- along with talk of
requiring them to lend money (stupid talk; making banks lend to
maxed-out individuals and cash-strapped businesses that aren't
creditworthy is the epitome of doing the same thing over and over and
expecting a different result), of caps on CEO pay and all the rest --
but it is virtually impossible to fully account for those funds when
they're ultimately being doled out by corporate managers. "Leakage" is
inevitable; there's really no way to guarantee that a TARP dollar
doesn't end up being spent on purposes other than for those which it
Another tool in the kit is to guarantee the value of the banks'
holdings -- essentially making the government an insurance broker
(this was part of the bailouts for Citi and BofA, and has been done
aggressively in the U.K.). But this may be the worst solution, for
much the same reason: as the underlying assets tank -- and most
analysts say we're not near the bottom in real estate -- the cost to
taxpayers will be enormous, and they'll get nothing in return.
The premiums required to make that insurance business profitable (or a
break-even) for Joe and Jane TaxPayer would be exorbitant, so banks
taking advantage of the program would give the government equity in
return -- again, that's partial nationalization.
Nationalizing the banks outright is another story. "The case for full
nationalization is far stronger now than it was a few months ago,"
Adam Posen, the deputy director of the Peterson Institute for
International Economics, told the New York Times. "If you don't own
the majority, you don't get to fire the management, to wipe out the
shareholders, to declare that you are just going to take the losses
and start over. It's the mistake the Japanese made in the '90s."
Nationalizing failing banks outright would be expensive, and comes
with risk, but it's a way to address most of the crucial flaws in the
ad hoc approach taken so far.
How would it work? The government would put teetering institutions
deemed too big to fail under trusteeship. Many among the current
management teams would join the ranks of the unemployed, shareholders
would get wiped out -- an important piece of tough love that might
dissuade people from following the herd into the next
And then the government would liquidate the institutions' assets in an
orderly, gradual way. Then, finally, it would sell back smaller,
leaner institutions -- without the burden of piles of bad paper on
their books -- to the private sector at a later date.
Proponents of the plan argue that taxpayers might even see a profit
from the transaction, but that's far from a given. The reality is that
while it's probably the least bad plan, and would likely result in the
lowest ultimate cost to the taxpayer, a similar approach, but far
smaller in scope, was used in the 1980s to bail out the savings and
loans and ended up costing taxpayers $150 billion.
Perhaps the best rationale for nationalization is that the bursting
bubble that precipitated this crisis wasn't in tech stocks or
commodities -- it was a bubble built largely on people's homes. The
New York Times, which continues to ignore the underlying collapse of
the housing bubble, notes that one of the flaws in the plan is that
"if the government is perceived as running the banks, the
administration would come under enormous political pressure to halt
But what they call a bug is obviously a feature of nationalization.
The foreclosure crisis is spreading, and foreclosed properties fuel a
vicious cycle, dragging down real estate prices in the areas where
they're concentrated, which in turn puts more homeowners "under water"
-- owing more on the mortgage than their houses are worth -- which in
turn increases the number of foreclosures.
If the banks were nationalized, the government could declare a
moratorium on foreclosures for the properties it controls, and move to
restructure mortgages -- perhaps at subsidized rates -- for homeowners
on the bubble.
This is an important part of the puzzle. So far, government efforts to
bailout homeowners have had little success, in large part because
privately held institutions have an obligation to their shareholders
to avoid writing down the principle of loans made on assets whose
values have tanked.
So far, all of the government's attempts to bailout homeowners have
been structured as voluntary programs, and the terms that the banks
require before deciding to bite have been too costly for most
distressed homeowners to afford.
It appears that the idea of nationalization is gaining steam in policy
circles, but the Obama administration has been hesitant to use the
word, perhaps wary of the reaction the proposal might get from
The New York Times reports, "President Obama's top aides have steered
clear of the word entirely," and the Washington Post notes,
"Administration officials are … trying to offer federal assistance to
financial firms without nationalizing them outright, according to a
source who has been in contact with senior Treasury officials."
Obama's Treasury Secretary, Tim Geithner, told Congress, "We have a
financial system that is run by private shareholders, managed by
private institutions, and we'd like to do our best to preserve that
system." But they may not end up with much of a choice. The Post adds:
"The problem is the price of banks shares is so low now that a major
investment of taxpayer money [in a recapitalization effort] would
leave the government with a majority ownership stake."
Barack Obama has promised a pragmatic approach to the crises facing
the country. Nationalizing big, failing banks may smack of "statism,"
but the consequences of tinkering around the edges of the crisis are
simply too dire; we've got to leave all options on the table.