Blue Mass Group

Reality-based commentary on politics.

Why nationalize banks

By

Option Result
Chapter 11 bandruptcy Not possible with banks: no one will provide debtor-in-possession financing other than the U.S. government
Liquidation A fire sale on a large bank’s assets would depress asset prices worldwide. It would trigger a depression.
Government purchase of toxic assets at market value Bank remains insolvent. Does not help.
Government overpays for purchase of toxic assets Opacity. Who else does one reward for bad assets?

Also moral hazard.  Further, this approach easily ends up equivalent to buying the bank
Government insurance of bad loans Taxpayers get all the downside, none of the upside. Huge implicit subsidy of the bank. (More moral hazard.)
Guarantee unsecured liabilities but leave assets alone Encourages risky behavior on the part of the banks (and its bondholders)
Nationalize Crazy gambles minimized. Taxpayers get upside as well as downside.
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  1. Krugman has become so politicized, you can’t trust his opinions: economist or politician.  

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    p>One good crisis and everyone abandons principals.  What’s wrong with the century old principal: feed insolvent banks to the FDIC; let solvent ones operate. New paradigm.  That’s the answer to anything, everthing: post 9/11.  New paradigm. Post October 2008, new paradigm.  Yet, with money and banking, it’s always come back to the principals: NPV is king, and when determining fair prices markets trump goverment.

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    p>But no says Krugman, let’s give the taxpayers some bank stock as an inaugeration present and let Barney Frank show us how well he can run it.  There’s an inaugeration present I don’t look forward to receiving.  Right about the time, say Raytheon or Fidelity or [insert your favorite Massachusetts company here] goes belly-up, how much political pressure is going to bear to keep feeding the dying company.  Bunches, I bet.

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    p>Krugman’s been chattering about nationalization for months. Let’s do like Sweden, he says.  Kinda like the single payer groupies “let’s be like France”.  But, to paint the obvious, we aren’t France or Sweden, so forget the berret and big tits and consider that Swedish banking is pretty much Stockholm, and therefore the banking system is a lot simpler.  Something tells me that a small country with its parliment and a bunch of socialists in the government is going to cozy up to nationalizations more easily than the US.

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    p>Have we ever nationalized anything? I don’t think so. That alone should be telling.  

    • “Have we ever nationalized anything?”

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      p>Conrail is probably the best example. But the TVA nationalized old private resources.

        • Conrail was a great success.  After the Penn Central imploded, no one thought that Railroads could make a profit.  Then came deregulation and about a year or so later iirc Conrail started seeing real profit, so much so that when Reagan re-privatized it, it was the biggest IPO in history at the time.

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          p>Conrail was such a success that both Norfolk Southern and CSX wanted to take it over and ended up agreeing to split the assets between the two of them.

            • I can’t read the article because it’s behind a pay wall, but if it includes any pre-Staggers Act losses in its calculations, then it’s pretty much meaningless.  Railroads were so handicapped by the ICC before then that none of them had made any money for decades.  

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              p>If you’ve read the article, please let me know how it takes deregulation into account and whether it compares the rate of return with the railroad industry as a whole and whether it takes the money made in the IPO into account.  If you haven’t read the article and you’re just playing the “appeal to authority” card, then we can play that game as long as you want to.  I work in the industry and my former company was one that worked on the Conrail/NS merger.  

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              p>At the end of the day, the Government took a giant railroad that collapsed completely — the Penn Central (plus some smaller ones) — and turned it into one that turned a profit.  Now, maybe if the Penn Central could have lasted through to the deregulation period, it too would have started to make money.  But we’ll never know because there were no private entities at the time willing to make that bet and take it over after it failed.  

            • The paper provides evidence that a state-owned firm with good governance could deliver superior performance.

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              p>How does that support you?  Seems to me it agrees with what sco is saying.

              • I said ‘some disagree’ because sco protrayed the publicly owned years as if Conrail was a profitable government investment.  The article makes clear the government lost money and yes, the 6.4% loss to the governent includes the period when government regulated the Company’s routes, wages, prices….

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                p>Now to sco’s point, the Staggers Act was massive deregulation when Unions were forced at gunpoint (not literally) to concede benefits; routes were abandoned, compelled by Legislation:  all this under the deregulation minded Reagan administration.  Essentially, the ownership was a receivership, much the same as a nationalized bank ownership would be today.

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                p>Now, fast forward to today’s Bank of America, nationalized:

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                p>1:  Comparing the situation to Conrail seems to be of some value, but not.  Conrail was overly regulated, and following the government’s receivership, government cooperated to deregulate, but took a hand’s off approach to operations.  Here we have the bank, the most regulated industry on earth (short of those that handle plutonium). Would government take a hands’ off and/or deregulate?  I’m thinking the opposite. i.e. there a Banking and Finance committee for a reason, and Barney Frank always interested in showing how smart he is.

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                p>2:  With Conrail, what didn’t happen?  What would have happened had Carter NOT taken over the rail?  Answer: it would have failed and the various bits and pieces would have been bought up by others.  The doomed Northeast passenger rail would have either stopped; it ultimately did anyway. Unions would have busted as non-union ventures bought up the defunct operations; Staggers Act ultimately forced concessions anyway.  I think there’s a valid argument that Carter’s nationalization simply stalled progress in rail deregulation for a decade.

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                p>3: The politicization of banking.  Recently, here in BMG, you have Rep Bosley questioning Legislation that favored large banks over small ones; Barney Frank and his perpetual push for home ownership for all. All potential good, or bad political notions made possible if the particular politician has a bank under his thumb.  

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                p>Say, let’s pass a law that bans construction lending for hospitals if they have abortion clinics. Or don’t have. Scary.

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                p>4:  And how about poor Citibank, JP Morgan, 1st BMG bank and trust, etc…?  How to compete against a government owned bank?  They make money the old fashion way; Bank America just prints it.  One thing the government can do cheaply is to print money.  

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                p>5:  What’s the proposed structure?  The government takes over Bank America.  Then what?  It gives the order by force of law to lend?  If that’s the case, then name me Gary L. Borrower!  I’ll be there with the other pigs at the lending window ready to scoop up some easy loans!

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                p>Again, what is the proposed structure?  How does Obama/Krugman/Rubin… suggest that a government owned bank will fail any less dramatically than the private one?  I’m suggesting that we consider the business model before taking on the risk of owning and operating a bank.  With Conrail, deregulation was clearly necessary.  That wasn’t government’s interference into operations; it was an externality.  With Bank America, it’s exactly the opposite: it’s the internals of the company that need to be addressed.  

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                p>

                • … assumes that transitioning to a more hand’s off approach is desirable for, or even a necessary condition for, such nationalization to be successful.  I’m certainly willing to entertain the assertion, but not as an assumption.  What is the story in the cases of ‘successfully’ nationalized foreign bank?  

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                  p>Reasonable assertion on number two.  More thorough research would be needed to back it up, but it seems a reasonable hypothesis.

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                  p>Three is interesting.  OT1H, I think if anything too absurdly political reared it’s ugly head in terms of government interference, there would be hell to pay.  OTOH, the government can and does incentivise some financial sector behavior.  If the bank were nationalized, it seems a little counter intuitive to suggest that they should swear off encouraging some specific financial behaviors directly since they’d be able to do so by other means indirectly anyway.

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                  p>Number four is the biggest ugly head in my opinion.  Public / private competition is possible, but the ultimate question of fairness always leaves doubts in such a market.  OTOH, I don’t see FedEx or UPS going out of business any time soon.

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                  p>Number five?  Certainly the devil will be in the details of governance, but foreign examples suggest working through those details successfully certainly isn’t an insurmountable task.

                • There’s no way to guess, but I can see it as a real possibility, not a ‘there would be hell to pay.’

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                  p>

                  Three is interesting.  OT1H, I think if anything too absurdly political reared it’s ugly head in terms of government interference, there would be hell to pay.  OTOH, the government can and does incentivise some financial sector behavior.  If the bank were nationalized, it seems a little counter intuitive to suggest that they should swear off encouraging some specific financial behaviors directly since they’d be able to do so by other means indirectly anyway.

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                  p>I can easily imagine a municipal financing of a City hospital in say, Kansas, and activists realize there’s no abortion clinic and ensuing protests that the Government is providing financing; financing for a construction project of a Bectel intermediary in say, Cuba, Iran…with activist outrage; Barney Frank sitting on a panel nittpicking the mode of transportation the CEO took to the meeting, or the fact that he has a club membership at a white only country club….

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                  p>Now, if you’re saying maybe Government should be doing that, then we likely have a fundamental disagreement of the reach of government.  Nevertheless, I can easily imagine any of those scenarios with a nationalized bank.

                • … I can easily see such a scenario.  I see it more of a possibility when policy people force particular financial transactions as a matter of policy.  I don’t necessarily see this as a problem when the management provides financing to said hospital as part of ‘regular operations’.  So I guess my point is that this situation is no different than any potential protest of government incentivising the transaction from the outside looking in.  Granted, such a nuance will likely be lost on those who protest.  

                • Certainly the devil will be in the details of governance, but foreign examples suggest working through those details successfully certainly isn’t an insurmountable task.

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                  p>That’s really my biggest point.  

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                  p>I have no doubt that there is a model of business that can be undertaken to make the Bank profitable once again.  Further, I have no doubt that a government civil servant can do it as well as a private employee, although one could argue ideologically about which could do it best.  I put that argument aside for now.

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                  p>My point is take it over, then what.  If you’re taking it over, for the sake of taking it over, you’ve removed the task of creating the functioning business model, and placed it under government’s wing, when there’s yet no proposed government solution.

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                  p>How do you compel banks to lend?

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                  p>If you wait for the market to decide, the pain via low GDP growth, may be great.  

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                  p>If you compel banks to lend via regulation and laws, there’s no guarantee of success and the cost of failure may be great.  BTW, there’s no consensus with economists that the New Deal was a success; a great many argue that it merely prolonged the Depression.

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                  p>My argument: Doing nothing is a bona fide option. Government, with respect to any Legislation, has the burden of proof that said Legislation will produce a good outcome.

    • First, the Wall Street entities were banks not subject to regulation. That was a big part of the problem and the FDIC has no jurisdiction over them. I’m not sure I quite understand what you’re suggesting wrt to the FDIC.

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      p>Do you disagree with the argument that bank failures are a very dangerous thing in a recession? If so, it seems that taking control via ownership is useful because it prevents money from disappearing into bonuses and stock dividends.

      • First, the Wall Street entities were banks not subject to regulation.

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        p>That’s a myth worthy of snopes.  There’s no industry that I can think of, short of those that handle dangerous material, that’s more regulated: State banking commissions, SEC, Federal banking commissions, FDIC, entire chapters of the tax code dedicated to the taxation of lending institution, Sarbine Oxley.  Media seizes upon on the repeal of Glass-Stegal and translate that into a ‘failure to regulate’ crisis when really the crisis was a ‘failure to realize’ what a leveraged thing was being created.

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        p>With regards to my FDIC reference, I’m referring specifically with Bank of America “BAC”, and asking why the FDIC is inadequate.

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        p>With regards to Wall Street banks, they too are/were heavily regulated, but the regulators and rating agencies just didn’t realize the dangers of the growing bubble.

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        p>And I reject the notion that bank failures are dangerous in a recession.  That’s the last war, circa 1929.  So long as the FDIC has the depositors’ backs, and responds quickly, the confidence of the consumer is kept whole.  IMHO.  

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        p>Also, the fear of disappearing cash via dividend is overblown.  A BOD has to approve dividends, and if it does so in an insolvent position, the BOD is put at risk.  I don’t see this happening.  Let’s test that theory.  I predict BAC will cut it’s dividend.  Stay tuned.

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        p>Same true of bonuses.  The trouble with the Wall Street bonus model is that it because customary.  People were hired based on i) salary plus ii) expectation in February of a bonus and adjusted their lifestyle accordingly.  When February arrives and the customary bonuses aren’t paid, there will be some serious dislocation in Southern CT and NY.  Bonuses, therefore will by design, continue, smaller than in prior years, but they will continue.

        • … were under regulated.  With more reasonable leverage allowances for CDFs, we probably wouldn’t be nationalizing anything right now.

        • One problem with the Wall Street entities, (Lehman, Bear Stearns, etc.) was that they were financing long-term debt on merry-go-round of short-term debt. They were constantly refinancing. One pays smaller interest rates if one pursues this strategy. Without regulation, the market gives one no choice but to pursue this strategy. However, it was an extremely risky strategy that they should not have been allowed to pursue.

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          p>When credit began to dry up, this strategy failed. Down they went. Lehman’s collapse accelerating the collapse of others.

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          p>They may have been subject to 100 lb of regulation but clearly something was missing.

  2. The stench of the bailout is almost unbearable at this point. And think, we wouldn’t even have to change the name of “Bank of America”.

  3. what is the process for them becoming private banks again when the times are good and lessons (hopefully) learned?

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