Bank Nationalization. Defining “Insanity”

by McQ | January 26, 2009 4:03 pm

I’ve tried to make the point in the past about how, regardless of anyone’s desire, there is going to be pain associated with the financial mess in which we presently find ourselves. The question is will an apparent aversion to pain lead government to soften it but also extend while doing so, or do politicians have the fortitude and will to advise us to endure the pain, get it over with and begin the inevitable recovery much more quickly?

As is obvious, it is the former pain aversion formula which seems to be the one our politicians choose. Because even short term but significant pain is likely to cost them their jobs, and, when all is said and done in matters such as these, that is what they end up focusing on.

However, what it means, according to news reports, is something I never thought I’d ever see contemplated, much less seriously considered in my lifetime.

Bank nationalization:

So far, President Obama’s top aides have steered clear of the word entirely, and they are still actively discussing other alternatives, including creating a “bad bank” that would nationalize the worst nonperforming loans by taking them off the hands of financial institutions without actually taking ownership of the banks. Others talk of de facto nationalization, in which the government owns a sizeable chunk of the banks but not a majority, with all that connotes.

That has already happened; taxpayers are now the biggest shareholders in Bank of America, with about 6 percent of the stock, and in Citigroup, with 7.8 percent. But the government’s influence is far larger than those numbers suggest, because it has guaranteed to absorb the losses of some of the two banks’ most toxic assets, a figure that could run into the hundreds of billions of dollars.

Many believe this form of hybrid ownership — part government, part private, with the responsibilities of ownership unclear — will not prove workable.

“The case for full nationalization is far stronger now than it was a few months ago,” said Adam S. Posen, the deputy director of the Peterson Institute for International Economics. “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.”

“I would guess that sometime in the next few weeks, President Obama and Tim Geithner,” he said, referring to the nominee for Treasury secretary, “will have to come out and say, ‘It’s much worse than we thought,’ and just bite the bullet.”

I’ve derisively cited the “Japanese model” repeatedly when discussing this on the blog and podcasts thinking, apparently erroneously, that we’d be smart enough to understand what Japanese government intervention ended up doing to their economy over the past two decades and not repeat that mistake.

Obviously I was wrong. As the government pumps in money in trade for stock in the taxpayers name (even though the taxpayers will never see a nickel of any future returns personally), nationalization becomes a de facto situation.

As the NYT points out, both Lawrence Summers (an Obama economic adviser) and Timothy Geithner (Obama’s choice for Sec Treasury) have made the point during the Asian financial crisis of the ’90s that governments make “lousy bank managers”.

Yet here we have government already hip deep in the banks and heading deeper. And even given the past experience cited, I guess we’re expected to believe that in this case, it will all be different.

Of course with de facto or actual nationalization, the entire political game changes. Politicians would have a new vehicle to enable pain aversion by short-circuiting the consequences of irresponsible actions by those who keep them in office:

Moreover, Mr. Obama’s advisers say they are acutely aware that if the government is perceived as running the banks, the administration would come under enormous political pressure to halt foreclosures or lend money to ailing projects in cities or states with powerful constituencies, which could imperil the effort to steer the banks away from the cliff.

“The nightmare scenarios are endless,” one of the administration’s senior officials said.

And, unfortunately, they’re only one part of the whole “nightmare sceanrio” this level of government spending and intrusion might bring.

“We told the Asians that they had to be willing to let banks and companies fail,” said Jeffrey Garten, a professor at the Yale School of Management and a top official in the Clinton administration. “We warned that there was great moral hazard if governments just bailed them out.”

“And now,” he said, “we are doing the polar opposite of our advice.”

Isn’t the definition of insanity trying the same thing over and over and expecting different results?

[Crossposted at QandO[1]]