Sunday, March 08, 2009

Nationalize? Hey, Not So Fast: New York Times Editorial

March 8, 2009

Economic View

Nationalize? Hey, Not So Fast

By ALAN S. BLINDER
New York Times

THE financial crisis grows weirder by the day. When philosophical conservatives like Alan Greenspan start talking about nationalizing banks, you know you’ve passed into some kind of parallel universe. Why are so many people entertaining an idea that sounds vaguely Marxian?

The answer, I think, is simple. We have some pretty sick banks in America right now, some of which may not be viable in the long run. But putting a giant bank through bankruptcy is unthinkable. (Remember Lehman Brothers?) And continuing the water torture that is keeping zombie banks alive is both expensive and dangerous. So why not just bite the proverbial bullet and nationalize them?

I believe in biting the bullet, but it matters which bullet you bite. Like Ben Bernanke, the Federal Reserve chairman, and Timothy Geithner, the Treasury secretary, I am not convinced that nationalization is the only, or even the best, way out.

Because “nationalization” can mean many things, let’s first clarify what the current debate is about. Don’t think Hugo Ch├ívez or even Clement Attlee. Imagine instead that the government acquires a majority interest in — or perhaps 100 percent of — a bank, wipes out the existing shareholders and installs new managers. Then, sometime later, a healthy bank is sold back into private hands, and we all live happily ever after. At least that’s the idea.

Sounds good, you say? And didn’t Sweden pull this off with great success in the early 1990s? Yes, it did, for which the Swedes deserve praise. But this is not Sweden. Let’s think about some of the downsides to nationalizing banks in America.

WHERE TO DRAW THE LINE? First and foremost, the Swedish government had to deal with only a handful of banks; we have more than 8,300. Numbers matter, because deciding where to draw the nationalization line isn’t easy. Presumably, no one wants to nationalize all the banks, thousands of which are healthy. But where do you stop, once you start?

Suppose we nationalized four banks. Bank Five would then find itself at a severe disadvantage in competing for funds with the government-backed quartet. Forced to pay higher interest rates to attract depositors and other creditors, its profitability would suffer. Soon, Bank Five might start looking like a candidate for nationalization, too — followed by Banks Six, Seven and so on.

THE DOMINO EFFECT As stock traders began to contemplate the nationalization of Banks Five, Six and Seven, their share prices would tank, and short-sellers might consign the companies to an early grave.

THE MANAGEMENT CHALLENGE The Swedes had a relatively simple task. They never had to deal with institutions of the size and complexity of our banking behemoths.

Mr. Geithner has emphasized that governments are ill-suited to manage businesses. I’d take the point a step further: Overseeing the management of dozens, or hundreds, or maybe even thousands of nationalized banks is a daunting task.

POLITICAL OBSTACLES The process of nationalization and reprivatization went amazingly well in Sweden partly because it was remarkably free of political interference. Would that happen here? You decide. My bet is no.

THE CONFIDENCE QUESTION Finally, because nationalization runs counter to deeply ingrained American traditions and attitudes, there is a danger that it might undermine rather than bolster confidence. As I said, this is not Sweden. The Treasury, of course, would never use “nationalization” in public; it would invent some nice euphemism. But the commentariat would not be so constrained.

All of that said, there are arguments in favor of nationalization. Or are there?

One is that financial firms are careening off track, thereby costing taxpayers more and more bailout money. (Think A.I.G.) That’s a big concern — and a major reason to seek quick closure.

But remember, the government already owns shares in many banks, and supervisors have immense powers to influence banks without owning them. According to a banking adage, “When your regulator asks you to jump, your only question is ‘How high?’” Because the Fed can pretty much dictate to the banks right now, what additional powers would nationalization bring?

Another argument is that banks’ dodgy assets are hard to value, making it impossible to know how much capital they need — and probably very expensive to provide it. True again. But nationalization doesn’t make these problems disappear.

If the government takes over a bank, the taxpayers tacitly acquire its assets, thereby inheriting all the uncertainties over valuation. And if a bank has negative net worth when it is nationalized, who do you think fills the hole?

SO, on closer inspection, the best-sounding arguments for nationalization are really arguments for bullet-biting. Worse yet, even talk about nationalization can be harmful if it puts bank stocks under further selling pressure. After all, who wants to own a stock whose value is heading toward zero? Which is why Mr. Bernanke and Mr. Geithner have taken pains to beat down rumors that nationalization is coming.

Unfortunately, their denials can never be categorical. If worst really does come to worst, the other options may evaporate, leaving the government no choice but to nationalize some banks. (Think Fannie Mae and Freddie Mac.) But, please, let’s not rush there. Let’s first at least explore what is called the “good bank, bad bank” approach.

What’s that? While there are many variants, the basic idea is to break each sick institution into two. The “good bank” gets the good assets, presumably all the deposits and a share of the bank’s remaining capital. As a healthy institution, it can presumably raise fresh capital and go on its merry way as a private company.

The “bad bank” inherits the bad assets and the rest of the capital — which, after appropriate markdowns of the assets, will not be enough. So, again, someone must fill the hole. And, realistically, given the mess we’re in, much of that new capital would likely come from the taxpayers.

Here’s a prediction: We will get to the good-bank, bad-bank solution sooner or later. Wouldn’t it be nice if it was sooner?

Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians.

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