Greg Mankiw today addresses an issue which has been nagging at me, but I have neglected to address. I’ve gotten a fair number of comments along the lines of “I’m opposed to bank nationalization, but I agree we need to do something, so put them in bankruptcy.”
Aargh. No one seems to have a problem with the FDIC shuttering bank, selling deposits and assets, and figuring out what to do what’s left over. Folks, that is a form of nationalization. What most people fail to recognize is that the FDIC tries to minimize how long it is in control. The reason the US had to resort to a bad bank in the S&L crisis was the FDIC and FSLIC had so many dead banks landing in their laps in a compressed time frame, and in particular, banks with some assets that were hard to value (think largely vacant new office buildings in Texas) that the regulators had to get extra funding to deal with the mess and come up with a variant of their usual routine to encourage other buyers to look at some of the bank assets.
The problem is that the procedures that work for small and even fairly large banks do not work for super big banks (so who would buy Citi’s deposits and branches, pray tell? And even if such a bank existed, do we want that much concentration? And what do we do with the junky assets, the private equity portfolio, the asset management business, its credit default swaps book, its various trading operations (many, ranging from FX, Treasuries, structured credits, money markets instruments, equities, junk bonds, derivatives, and I’m sure I’ve missed quite a few). These banks are not simply bigger; they are in a far wider range of businesses than the typical FDIC basket case, with a much larger geographical footprint (typically substantial foreign operations) and more complicated operations (meaning management information systems, financial reporting, transaction processing, customer reporting, risk controls).
It’s hard to convey to people outside finance why a big complicated bank isn’t the same as a manufacturing business or a retailer, where you can resort to Chapter 11. The simplest explanation may be that banks are much more tightly integrated into various customer and counterparty webs than most other businesses are. If a big automaker wants to shut down a production line for a few hours or a week. it can be done with little disruption to outside parties if planned. It isn’t acceptable for a trading desk to shut down for a day, say to do “routine maintenance”. Counterparties would run for the hills the next chance they had a chance to initiate trades. Now one might argue that this is convention, but as a customer, not being able to trade, not having ready access to one’s funds is seen as an unacceptable risk, and that business requirement makes it impossible to resort to Chapter 11. By definition, creditors are held at bay. That means they CANNOT access their positions (certain changes that were part of the 2005 bankruptcy reform in fact allow certain parties preferential rights, but enough are at risk of being frozen in Chapter 11 that credible information that a trading operation is going down is enough to precipitate a run, as happened with Bear).
I know that that is a gross oversimplification of the procedural issues, but I believe it conveys the essence of the problem.
Mankiw thus favors nationalization, or what he calls, following Calculated Risk, “pre-privatization”, as the best fudge we can come up with in lieu of having a regulatory/bankruptcy regime that addresses the peculiar nature of large, possibly systemically important, trading organizations.
From Mankiw:
Why are people scared about the idea of nationalization? One reason is that it is a sign of the depth of our problems. A second, more substantive reason is that it seems to point in a bad direction. I certainly do not want the government deciding who deserves credit and who does not, what kind of investments are worthy of financing and what kind are not. That is a big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.
If the government is to intervene in a big way to fix the banking system, “nationalization” is the wrong word because it suggests the wrong endgame. If banks are as insolvent as some analysts claim, then the goal should be a massive reorganization of these financial institutions. Some might call it nationalization, but more accurately it would be a type of bankruptcy procedure.
Bankruptcy could become, in effect, a massive bank recapitalization. Essentially, the equity holders are told, “Go away, you have been zeroed out.” The debt holders are told, “Congratulations, you are the new equity holders.” Suddenly, these financial organizations have a lot more equity capital and not a shred of debt! And all done without a penny of taxpayer money!
One of the problems in talking about nationalization is there is very little consensus on what the word means, Indeed, in reading the press, columnists, fellow bloggers, and comments, I can see a wide range of assumptions, hidden and explicit, at work. The more we start clarifying what we mean, the better chance we have of sharpening debate and coming up with viable approaches. And I strongly suspect, as Mankiw suggests, that the advocates and opponents may have a lot more common ground than they realize.
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Yves
Thank you. This was truly a helpful, informative post.
Mankiw:
“A big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.”
That’s different from what we’ve got now how, exactly?
lambert,
Didn’t want to seem churlish by pointing that out, but couldn’t agree more.
“A big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.”
Yes, that jumped right out at me too.
There’s an important distinction between the bank holding companies and the depository institutions that they own. Existing law has special provisions for insured depositories; holding companies fall under bankruptcy law.
Now, nothing was changed in the deposit insurance laws after the repeal of Glass-Steagall. So we have a mess. When people talk about “Citi”, they can mean either the insured depository or the diversified financial services holding company.
There are laws to deal with the nationalization of depositories that refer to the concept of “too big to fail”. The phrase is a misnomer–it refers to the deposits being insured 100%, not to whether the institution can be placed into receivership or conservatorship.
For example, Indymac was nationalized — the bank reopened as a de nouvo institution capitalized by FDIC, and the shareholders and bondholders of the holding company became general creditors of the estate. But Indymac was not too big to fail — in the sense that the depositors were not paid off 100%. I believe the holding company filed bankruptcy shortly after the banking sub failed. In any case, neither FDIC nor the `new’ Indymac has anything to do with the holding company.
Now the problem is that the government wants to protect all of the pieces of institutions such as Citigroup. There is no controlling law in this case. So what they’ve done is a government recapitalization without nationalization. What rankles the public is that management was not replaced and that austerity was not imposed. The treasury could have structured its assistance in a way that required representation on the board, but, like the Fed with AIG, it declined to do so.
Professor Mankiw, I’m shocked! Listen up–
Toxic assets are created by toxic credit cultures (which, despite the press, is not all banks).
The oligarchs of the zombie banks appear to be launching a campaign of negative "analyst reviews" of healthier big banks than theirs, to beat down potential acquirers of parts of their businesses. U.S. Bank seems to be the current target, a bank that has financials a lot prettier than most–but watch for BB&T to come next. These are exceptionally well-run, conservative banks, not located in New York City, and they scare the crap out of the oligarchs with all the talk of receivorship going around.
In passing, I note that the Republicans could finish off their political hari kiri by voting to spend taxpayer money to bail out the zombie banks after all of them voting against the stimulus. They're slow, but they seem to be getting this. But maybe not…. Let's hope the spendy Dem's don't make an impulse purchase of trillion or so of crap to "help out."
A big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.
Mankiw is no innocent babe in the woods when it comes to political economics, and has himself worked in an administration with, ahem, a few potential ethical conflicts in its relationship with business.
This irks me as badly as those who continue to pose moral hazard as a hypothetical issue that could occur in the future. Its inclusion is almost more offensive than omission would have been, with the implicit assumption that his reader is that gullible.
Regarding the main topic, nationalization of the banks, I have no qualms with it and it’s probably the best way to wipe up the present mess. Mankiw did a good job presenting it. But I still think it’s tangential to persistent, underlying problems in the real economy covered for too long by the creativity of finance, and alone not really a cure for anything.
Excellent post from Greg and commentary from Yves. I have a question that follows on Martin Wolf’s critique of the ‘stress tests’ and the argument that this administration is too scared to admit that many/most of the banks are already insolvent. Are there enough ‘honest’ brokers capable of doing the audits on all these assets the banks hold? I don’t know. I get the sense that there aren’t, and that part of the reason Geithner and Summers don’t want to go down the nationalization road is that they don’t feel the administration is up to the job of running the banks/running the audits. Is this an unfair assessment?
I get the sense that there aren’t, and that part of the reason Geithner and Summers don’t want to go down the nationalization road is that they don’t feel the administration is up to the job of running the banks/running the audits. Is this an unfair assessment?
If Geithner and Summers are manifestly clever enough to manage the restructuring of the automotive industry, they’ll surely think themselves able to handle this mess too, 11:05. Summers, in particular, is probably capable of walking to the moon, though hypothetically bounded in velocity by the speed of light.
I still favor the simplest explanation. They’re close friends with the banks and their leadership and believe things can be sorted with a sufficiently clever and contorted policy, as Geithner originally set forth. That Committee to Save the Solar System Time Magazine cover is so close they can taste it.
i think CR nailed it with preprivatization.
let me add that i think the real problem is yet again the obama administration is willfully injecting ambiguity into the media. they continually choose the term nationalization and frame it as antiamerican. they do not discuss the kind of restructuring yves and numerous others have proposed – EVER! They don’t even attempt to make distinctions. and lets remember that obama is a verbose mf, he ran a campaign on nuance. the disinformation campaign is willfull – at least thats my theory and im sticking to it.
Early Withdrawal,
Agreed on your point re ambiguity. That is the reason I got upset with the “stress test” malarkey. Geithner gave the impression it would be precise and exhaustive, when all it can be is very quick and dirty. That is still better than nothing, but I am bothered by the dishonesty.
The banks are already private, so I think that “re-privatization” is more appropos. fwiw.
Fannie & Freddie were were full blown, government-owned and operated agencies for the first 30 years of their existence. Until 1968, they were just another part of the alphabet soup. Does history show any problems there? For that matter, there are many state banks in India….let's see, out of all the banks in trouble in countries across the world, I don't seem to recall hearing about the banks in India being in dire straits.
Of course, nationalization will never be a cure-all; we've got to stop leaping from one dogma to the next. But I hope American society ends its fantasizing about the primacy of the market.
a riff on ndk’s thoughts… not only are we still not addressing root issues within the financial services industry ( we would want to rush regulation per greenspan ), but the US isnt any where close to grappling with the immense presure from global wage arbitrage. one can not ignore the destabilizing effects of india and china if one wants to get to the bottom of how we got here. even with cleaned up banks and home prices moving to 1/3 annual income ( we hope ), it seems to me this is not likely to be the end of deflation. even in economic recovery wages will continue to fall, which will continue to bear down on consumer assets – namely cars and home. with a cleaned up banking system we may recover soon but it may still look like we’re going down.
comments welcome.
Corx – we wouldNT want to rush
These keys are little. But the sofa is nice.
I get the sense that the administration is floating trial balloons, and Greg is weighing in a way he usually doesn’t. Our legislature is usually pretty careful about who they piss off, which is why the trial balloons are lifted. Nationalism is the hardest to explain to the electorate, and doesn’t do much to endear wall street CEOs. So I can’t help but sense that important people are coming to the realization that this is the direction we are heading.
a riff on ndk’s thoughts… not only are we still not addressing root issues within the financial services industry ( we would want to rush regulation per greenspan ), but the US isnt any where close to grappling with the immense presure from global wage arbitrage
I strongly agree with this, Early Withdrawal, but I would add that there are immense structural deflationary pressures from global capital oversupply as well. Capacity utilization at U.S. factories hit a record low of 68%.
The benign financial climate, globalization, and increased trade of the past 20 years have pushed these structural trends to extreme levels. Just to pluck one example, China’s steel capacity is 660 million tons. That’s preposterous.
I see absolutely no reason why equilibrium real interest rates couldn’t be structurally negative, especially after the scorching global investment growth and expansion of labor pools we’ve just seen.
Yves:
What if we reinstated exactly Glass -Steagall and forced quick separation. Is it not the commercial bank activities which are most needed to resume lending? So attention and capital needs be concentrated there first.
As for the Investment Bank section ????
pls
Seems like something needs to be done and rather quickly if the run on Stanford’s accounts is any example, world wide, people are losing faith fast.
It won’t be long before folks just start pulling whatever they have out of the system altogether.
Yves,
Thanks for the great posting.
Excuse me but I laughed when I read Mankiw’s ending lie: “And all without a penny of taxpayer money.”
My requirements are that we end all “investment/ponzi banking”, ferret out the criminal behavior and prosecute it agressively, reregulate banking to be a public service utility and migrate to a world money supply that cannot be manipulated by population minority countries.
Yes, I want it all! The corporatists or fascists have had it all and look and what they have wrought. It is time for structural change.
The cost of nationalization is going to be loss of intellectual property rights held by American and European companies.
Do you really think any country is going to respect intellectual property rights when a large portion of their savings have been wiped out by the largest con in Anglo-Saxon history perpetrated against the producers and savers of the world?
Then, with globalization dead and the reset button of capitalism having being pressed, we will start all over again. But, this time around, socialism, with a lot more central planning will be the new capitalism.
The wild card will be how India, China, and the US decide to secure their energy/oil supplies. These three countries make up half of the world’s population and they will not be held hostage by the 3% of the world’s population that just happens to sit on 1/2 of the world’s oil reserves.
On a side note, just like the depression, it will be those with cash that will thrive.
Sukh,
Who said nationalization would wipe out depositors? That happened in Iceland, but it isn’t a give at all here. The big priority is to wipe out shareholders, and maybe have bondholders take a haircut.
Most of all I like the canard about banks being too tightly integrated to disintegrate them into smaller chunks.
Minnesota and other midwestern states banned branch banking until recently. Each bank had its own president. I remember buying my first car and shaking the president’s hand when he handed me the payment coupon book.
Compare that to the packaged, warehoused, swapped, tranched, marketed, FICO scored garbage being called loans today.
I already see local credit unions making a comeback taking away a lot of business from godzilla banks. Small local banks and CUs are the wave of the future.
Mankiw is sub-par. He is the GWB of economic analysis. Bad, wrong, delusional? You need not quote him as an any indication of consensus.
Why bother Ms. Smith?
Should we prowl the mental hospitals for consensus?
And then there are proposals for new “good banks” which might be created by the Govt. in order to restore the flow of credit. There is this proposal at Angry Bear and two others discussed at The Baseline Scenario.
If nationalisation isn’t going to be just a Govt.-managed liquidation, you need to think about recapitalisation as well. This could be hugely expensive for the taxpayer, particularly since nobody seems to know accurately just how bad the balance sheets of the big banks are. Maybe the “stress test” will shed some light on this, and if it does nationalisation arguments can be put on a better footing.
But those who have an ideological (or maybe religious) objection to nationalisation should remember the US Govt. nationalisation of the railroads in WWI. It’s been done before, big time.
I imagine in the future that each country may create a backstop bank, staffed with reasonably competent people, government run, that is ready to take on the big bank failures. Something under the FDIC perhaps in the US.
It bothers me that the large banks are such a financial risk, both in takeover, and in arbitrary support.
I will offer another one. How can Germany manage to divest all of East Germany, and the US cannot figure out how to manage nationalization and divestment of a couple of lousy banks?
The answer is, the banks need a trustee. I have a job for Volcker and Greenspan. Volcker takes Chiti & WellsWachovia, and Greenspan takes JPMChaseWAMU and BofA. Yeah I know JPMChase is supposed to be good shape, same for Wells. Get rid of them. Bye-bye.
You are correct. Many of us who wanted the Swedish Plan since September knew that some banks might be nationalized, some not, but that the debts and management would be purged in any case. Many people are advocating what we were calling nationalization under another name or slightly different form.
I also agree about the FDIC. The reason that some of us avoid mentioning them is that the task of swooping in on these monster banks in the normal mode of the FDIC doesn’t seem possible. Whether you create a new temporary overseer or give the FDIC an expanded mandate, also can come to the same thing.
The main points are wiping out shareholders ( I’d wipe out the bondholders as well, but I understand why some people don’t like that ), getting rid of the management, and cleansing the books. Then spitting them back out.
I also favor a narrow/limited banking system, but that’s a different matter and most people don’t seem to like the idea.
My main reason for calling it nationalization, which I’ll admit scares a lot of people, is precisely that it scares a lot of people, including bankers. For moral hazard reasons, I insist on calling it nationalization, because it causes bankers nightmares. Anything short of that they consider a victory, which is why you keep hearing so much about it, even though most of us who favored the Swedish Plan months ago had no intention of the government running banks for a long time. In fact, I argued that Hybrid plans like TARP were much more likely to have long term negative consequences, and be harder and costlier to get out of. So,let’s call it nationalization whatever we do. I guarantee you that bankers will never forget it. That’s moral hazard.
Don the libertarian Democrat
Let’s be clear; by nationalization one means the entity is owned by the nation, administered by, or at least with the oversight of, the state, and funded by taxpayers, i.e., public ownership. Anything less than this is not nationalization. As such, what is eventually done with the entity, and what that entity’s purpose is, meaning what use it is put to, is then, at least potentially, a matter of public concern and thus public debate. The issue then arises, or at least potentially arises, as to what is in the best interest of the public.
We are witnessing the expansion of state intervention in the economy in an attempt to steer the economic system away from crisis. As that intervention increases, so does the need to validate and legitimate that intervention. One side effect of this is that the success or failure of said intervention will demand greater and greater accountability of government actions. These decisions then become not only economic ones but also, increasingly political. Those in the seat of political power, knowing full well that they will increasingly be held accountable, will seek to validate and legitimate their actions in the only way that is available to them (at least in a democracy): by generating public support. To generate that public support they must be able to convincingly (or at the least fain to do so), demonstrate that what they are pursuing is in the interest of the nation as a whole, that is, in the general interest and not solely in the interest of private parties.
The powers that be, of course, recognize this fully. They know that pursuing this course could very well set a precedent, one that risks opening up a can of worms, letting the cat out of the bag, that is, setting a precedent that the public may demand more follow through, in which decisions regarding the direction of the economy and the resolution of the unfolding crisis be handled in such a manner that it address what are generalizable interests – as opposed to, or limited to, private interests.
Commentators attempting to describe nationalization, or conceptualize it in a way that is not looked upon as unacceptable, or in the reverse, attempting to normalize it, seem to be carrying on the debate in technocratic terms, contained to just technical matters relegated to the financial sphere. This seems rather naive. Political decision makers know otherwise.
In any case, as more talk of “nationalization” takes place, the shares of BAC, C, etc., are pounded into dust, making the very outcome of “nationalization” inevitable.
Good points Don. At its root, this is not an economic problem, but a political one, and the “n” word should be used to full effect. Affect?
And whoever made the comment about Germany/East Germany…I busted out laughing. I don’t know if there is equivalency between the two situations, but yours was certainly a smart comment, in more ways than one. Very clever. Thanks for the laugh.
Don,
So you’d rather see taxpayers continue to write checks on an open-ended basis to banks and bankers, with no controls (the private jets and pay business is just show for the public)? That’s the alternative, and it stinks. No private investor would put this much into an entity without having control and upside. Why should the American public get a worse deal? The idea that the private sector is something sacred is rubbish. These companies have run the economy into the ground and ruined many lives. They have NO moral or practical high ground to stand on.
Nationalization is inevitable unless Geithner can somehow trick the public into accepting a trillion-dollar giveaway. The banks need something like a trillion dollars. If the government does an FDIC-style takeover it has to run them until the assets are sold, and it’s going to be years before the requisite capital can be put together considering the huge amount, economic uncertainties, and the unclear values of the toxic assets. In the meantime, the government will have to run the banks.
People who find the government running the banks objectionable should remember this outcome the next time they argue against regulations.
Also, private operation of the bank has destroyed the world credit market and put us at serious risk of a Greater Depression. For those concerned with government-run banks; can you think of any nationalized bank which produced a worse outcome in any country not profoundly corrupt? I sure can’t.
Don, with all due respect, I think it’s a bit late to talk of opening a can of worms.
To FairEconomist
It was government meddling and regulation that brought about mega banks, especially at the congressional level.
If you look at bank history, the smaller banks provide the needed consumer credit. Industrial credit was provided by large city banks. Somehow this model was horribly disturbed since the quasi-privitization of Fannie and Freddie. The Fs by the way are classic government tweaking and milking for lobby interests. They never were private, only in the minds of stockholders.
Government banks do not work. The Fed has not worked throughout this crisis. A government megabank will behave just like the central bank of Zimbabwe as a piggy bank for politicians, until it all goes in the crapper. Then it will continue to be there as means to keep up the lifestyles of the politicians.
Let’s go anti-trust (by the way, where was Sherman during all the bank consolidations?) for the big banks, and do a reset of private banking.
I simiply cannot imagine the federal government doing a reasonable job of dispensing credit. The very notion makes me shudder.
Folks! Mankiw is only technically talking of nationalization. It’s just nationalization for an instant.
Zero out the shareholders, zero out some amount of junior creditors, award new shares to the former senior creditors, and the company continues as a privately owned entity.
It’s like a prepack Ch. 11, or “pre-privatization”. The government does not actually operate the bank (for any significant period of time.)
PrintFaster,
With all due respect, just about everything you say is wrong.
The mega banks are the result of DEREGULATION, specifically, ending prohibitions on interstate banking, the erosion and then elimination of Glass Steagall, the ending of regulations on bank deposits. The S&L crisis was a direct result of deregulation (S$Ls before had been permitted only to make a small range of loans. As they were deregulated, they used cheap deposits to fund all kinds of stupid high risk lending and investing.
I could go on. The local bank model you applaud was a staple during the era when banking was highly regulated. There were 16,000 banks in the US in the late 1980s, and that was after a spell of deregulation and consolidation. I believe there are now under 7,000 banks.
The Fed is a private bank. The US government has subcontracted the functions of a central bank to it. There was a period in US history when the functions of the central bank were performed by the Treasury.
Anonymous,
Who said nationalization would wipe out depositors? That happened in Iceland, but it isn’t a give at all here. The big priority is to wipe out shareholders, and maybe have bondholders take a haircut.
___________________________________
Depositors (mostly Americans) will be save. My thinking has been that foreigners are the largest bondholders and they are going to be the ones that are screwed. And my thinking is that the haircut will be more like a crewcut :).
Sukh
I will try to make here few more logic points:
a) if we agree that some banks ended up being “too big to fail”, it is logic to me that we have to break them up in smaller ones. In this respect I do not see why we should go for a wholesale or centralized bank model. We do not want a centralized credit system we want a decentralized one, more democratic and more accountable. Wholesale banking means also concentration of assets and we do not want it, don’t we?
b) about nationalization, I have not yet read the compelling case for a state ownership. Nationalization can refer to something different (read on my blog well). As far as possible ownership should be public but not necessarily state. If funds come from Treasury, that is taxpayers, it could make sense that taxpayers are allotted some shares. We can then work out the details on how represent the best interests of the new taxpayers shareholders or other private investors involved. Treasury funds are just “seed” money without which the new good banks operation is difficult.
c) about what is going to happen to bondholders, it also depends on how the markets will react to the proposal of new good banks. There is scope to restructure those loans and see who hold them while also offering them a refinancing deal in which a debt holder gets an equity or loan position in the new banks. Alternately bondholders could stay in the insolvent banks and see what it comes out from their liquidation.
d) under the above circumstances, I do not see the run on bad banks, although their stock prices may have already reflected that scenario. Depositors could be moved in good order and gradually. If they prefer the new good banks let it be, that’s market…
"The more we start clarifying what we mean, the better chance we have of sharpening debate and coming up with viable approaches. "
I couldn't agree more.
"Aargh. No one seems to have a problem with the FDIC shuttering bank, selling deposits and assets, and figuring out what to do what's left over. Folks, that is a form of nationalization."
Exactly. Between explicit failures like IndyMac and forced mergers, about 10% of the deposit base has been "nationalized."
Unfortunately, given that the problems are most acute at investment banks, a lot of that has been undone by BAC/MER and JPM/WM.
Steve @ 10:57
"For example, Indymac was nationalized — the bank reopened as a de nouvo institution capitalized by FDIC, and the shareholders and bondholders of the holding company became general creditors of the estate. But Indymac was not too big to fail — in the sense that the depositors were not paid off 100%. I believe the holding company filed bankruptcy shortly after the banking sub failed. In any case, neither FDIC nor the `new' Indymac has anything to do with the holding company."
Excellent post and explanation regarding how traditional banks are currently being handled. Plus your observation regarding the effort in trying to keep the investment banks functioning via subsidies designed for regulated traditional banking.
Benign @ 11:01
"The oligarchs of the zombie banks appear to be launching a campaign of negative "analyst reviews" of healthier big banks than theirs, to beat down potential acquirers of parts of their businesses. U.S. Bank seems to be the current target, a bank that has financials a lot prettier than most–but watch for BB&T to come next. These are exceptionally well-run, conservative banks, not located in New York City, and they scare the crap out of the oligarchs with all the talk of receivorship going around."
I don't know the evidence, but the traditional banks are getting more vocal about their competition getting bailed out at their expense. The CEO of USB did so in a speech last night and went far enough that he had to retract part of it.
The president of Mid South called for breaking up the big banks. http://www.marketwatch.com/News/Story/Story.aspx?guid={578BDAD1-5FA5-4704-8157-6D265DDE84A4}&siteid=nbkh
There is an argument for bailing out investment banks, but pretending that they are traditional banks is the wrong way to do it.
It has to be driving the stronger community banks crazy to hear people casually assert that they are insolvent. If the economy gets bad enough, every leveraged financial will have problems.
They have been at a competitive disadvantage to the originate to distribute competition for years. Now that their competitors have blown up the system, they want to morph back into the traditional sphere long enough to get bailed out.
Wow, the stream of “mea culpas” is getting stronger by the day! First Greenspan (“need more regulation”) and now Mr “Laissez-Faire” himself (Mankiw) stepping up to the plate to call for the N-bomb (nationalization) to be drooped.
Did somebody just say “we are all socialists now”. Indeed!
Of course, you couldn’t expect unqualified common sense from Mankiw … This bit in particular I just love: “A big step toward crony capitalism”. Hey Mankiw, don’t you *get it*? We have *had* the crony capitalism already !!! This is why we now find ourselves where we are; contemplating pulling the pin and rolling in the N-bomb. Does he really think that US govt *wants* to take over the banking sector? I’m sure they are just relishing the thought – not! It *is* the option of last resort. Unfortunately due to the crony capitalism of the Bush II years (remind me who was the economic advisor – ahh yes, I remember now!), this is what we face today.
Please keep in mind that a combined debt cramdown/debt-to-equity conversion, which is one pretty likely version of what will eventually happen, will lead to massive losses in asset managers and possibly precipitate another crisis elsewhere, namely in the huge insurance sector. Many have criticized Geithner for hesitancy but the foreseeable and unforeseeable consequences of a “nationalization” make hesitation a reasonable reaction. What disturbed me about the stories emerging about Geithner isn’t that he didn’t present a plan, but that he wasn’t familiar enough with the issues in November to already know exactly where this was going. I’ll give Paulson credit for probably being aware of all the problematic consequences.
jult52
Two other comments: I hope everybody read Steve’s 10:57 post. Tracking the legal entities involved in these matters is key. Instead of thinking of these banks as a “firm,” visualize them as networks of connected legal entities.
And did Printfaster really refer to the integration of East Germany into West Germany has a model?
jult52
“A second, more substantive reason is that it seems to point in a bad direction. I certainly do not want the government deciding who deserves credit and who does not, what kind of investments are worthy of financing and what kind are not. “
We’re already a long way down that road. New credit only goes in any volume to those sectors and in those formats where the government provides guarantees, effective guarantees, or cheap finance. I fail to see how outright nationalisation would make that any worse.
You have to wonder if this talk of nationalization isn’t calculated to give the creditors of Citi and BofA a chance to get out. The stocks price of both continue to drift to zero. The issue is what institutions are exposed to the failure of Citi and BofA. Nationalization doesn’t really solve this problem because the real question is this: What would it mean to say that the money loaned to Citi or BofA is genuinely lost to the creditor? Or to put it another way: Is there really an economic loss involved in making the creditors of Citi and BofA whole?
It’s always bankers who tell us how important their trading desks are and that the world can’t survive without them. Let’s not forget that those desks create no value and that liquid capital markets have been unable to make productive investments.
And please don’t tell me how hard it is to value a vacant office building in Texas. Let’s think about the value of those derivatives. Extra funding and new variants will not help to value those. That quite simply takes time. We can drag it out. Or, we can compress it.
Mankiw’s suggestion that the equity holders be zeroed out and the debt holders become the new equity holders is a good one. But I know in my heart that it will never work like that. The “good” assets (those that can be valued) will be sold off to some PE oligarch. The “bad” assets (those that cannot be valued) will be chained to the taxpayer. I’m not so concerned about more crony capitalism in the form of govt making lending decisions. We’ve had that for a long time by virtue of the AAA lending list.
Let them fail. If the banking industry comes out of it flat on their backs. Who cares? We’ll be making investments from retained earnings. Like we should. No more oligarchs, no more AAA list, no more house rules in the casino, no more competitive advantage simply because you have that access to capital.
Kudos to Yves, Mankiw and anyone who can move us past totemic words (‘nationalize’) toward common sense and meaningful distinctions.
But, I must say that reading this from Mankiw is difficult to take:
certainly do not want the government deciding who deserves credit and who does not, what kind of investments are worthy of financing and what kind are not. That is a big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.
Mankiw was a cheerleader for exactly this kind of crony capitalism — only in his version the government made these choices by backing the ‘free market’ ideologues who destroyed the economy.
Really, it’s just hard to take someone so ideologically dyed that he cannot even seem to see that he is the first violator of what he preaches against.
Yves:
Then I’ll handle the churlish part then, shall I? As part of a layered architecture ;-)
Yves
With all due respect, it would seem that the view you present is one dimensional.
First, the Fed. You assert that it is a private bank. It is a private bank in name only. It is under constant, direct control of congress. It is even less a private bank than Fannnie or Freddie. It is exemplary of the control of congress and not the executive of banking function. If you will notice the pattern of corruption in government, while there have been notable abuses in the executive, the monstrous bulk of corruption has taken place in congress.
In order for banks to become large, they require acquiecense of banking supervision. Here both congress and the executive have played a role in merging banks rather then letting them fail. They have both abrogated their role in managing antitrust to favor large campaign contributors and lobbyists. The fed is an example a banking monopoly and concentration, along with the current banking oligopoly both created by government action.
Yves, you are confusing government actions with government supervision. Supervision is constant, *minimal*, and even tempered. Government actions, are severe, emotional, and subject to corruption. Supervision is the Nuclear Regulatory Commission. Government action is TARP, et al. The closest to financial supervision has been the FDIC, which has been transformed into sort of a garbage collector. Banking supervision has migrated to congress and the upper part of the treasury.
So to recap, we have left the era of banking regulation, to an era of banking meddling exemplified by the Fed, Fannie, Freddie, and alphabet soup.
I am afraid the consensus is on the wrong meaning of nationalization, which scares everybody. I contend that ownership does not need to be of state. If private investors and taxpayers or other communities are allotted some shares, would you call it nationalization? If bondholders swap their debt for equity in the solvent and/or new good bank, would you call it nationalization?
Yves, I'm encouraged you try to clarify "nationalization" some. I bet you the Obama administration will have to use different language. There's no way to re-educate the body-politic quickly enough because even reporters are simply uninformed.
For instance, NPR morning edition on the 18th interviews an economist who claims "nationalization" will create (implying it did not already exist!) a transfer of wealth from taxypayers to bondholders.
This is what we are up against when we use the term "nationalization".
Even though Dean Baker commented at the site, I wonder if NPR will follow up and get it right….
I'm not holding my breath.
Also, when you say: "so who would buy Citi's deposits and branches, pray tell"
Well, such a huge bank would have to be sold off piecemeal. So perhaps about 70% of those ATMs and 50% of the branches or whatever could become the property of perhaps 10-20 smaller banks.
Finally, for your amusement, my post on the language of "nationalization"–>
http://findingourdream.blogspot.com/2009/02/language-of-nationalization.html
The case for not nationalizing the LEMON BROTHERS, since there are alternatives.
Yves,
Can you specifically address this section of Greg’s post:
Bankruptcy could become, in effect, a massive bank recapitalization. Essentially, the equity holders are told, “Go away, you have been zeroed out.” The debt holders are told, “Congratulations, you are the new equity holders.” Suddenly, these financial organizations have a lot more equity capital and not a shred of debt! And all done without a penny of taxpayer money!
This makes total sense to me. Alan Greenspan has spoken against this approach saying that the senior debt of the banks should be an anchor to the system. In my opinion, it’s now an albatross.
Best regards
Define ‘nationalize’. IMO it would be a big mistake to nationalize banks (as I understand that) — confidence in ‘the system’ will be badly damaged for a long time. Instead the government ought to inject capital via purchasing preferred shares, but under less advantageous conditions than Buffett usually manages to negotiate. Much less advantageous, i.e. the government can afford to wait for its dividends etc.
This makes total sense to me.
So if the government goes about ‘zeroing’ common shareholders in some kind of ‘pre-privatization’, don’t you think that will make it a tough sell later when they actually want to privatize the bank? Which I assume they would.
eh, the bank is reprivatized by the very act of awarding the equity to the former creditors. There is no next step, it’s all done!
I’ll assume that trading counterparties are not directly affected by this; the bank’s trading book continues, and whatever credit improvements or worsenings happen as a result of this process will accrue to the counterparties. In some cases, where the trade involves a loan, that loan could become equity and the trade will look much different, but them’s the breaks.
Mankiw: “That is a big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.”
What the fuck does he think we’ve had in the US financial system for the past decade or so? First we got the crony capitalism and now we’re getting the economic stagnation.
Mankiw sounds almost as clueless as this pinheaded GOP congresswoman:
Rep. Sue Myrick of Charlotte called nationalization “absolutely a no-no . . I mean the government running the banks? Talk about a disaster.”
I’ve no doubt a bunch of French-style socialist bureaucrats (like the ones who ran Credit Lyonnais into the ground) could jin up a pretty big credit crisis, given half a chance. But they’d have to really work at it for a while to match the one we already have.
There are so many things wrong with the assumption that “bankruptcy can’t work for banks” that it is hard to know where to begin.
Many observers, apparently including Mankiw, are completely confused about what is bankruptcy and what is nationalization.
The proper understanding of bankruptcy is that it is a legal procedure whereby a firm’s assets are liquidated and its contractual obligations nullified via a properly constituted court — to the extent there are assets, creditors of the firm are repaid.
Nationalization isn’t bankruptcy. Nationalization is a government seizure of a firm without the consent of the owners/shareholders — the government then becomes the “owner” and proceeds to run the firm’s operations.
Nationalization is not a legal process but a political one i.e. there is no due process to the owners (or creditors for that matter). The government may choose to “reprivatize” some, all, or none of the firm. It may run the firm as it chooses, dictating production, compensation, and every other aspect of the firm’s operation. It can pay officers what it chooses; it can provide services to whom it chooses and under what conditions it chooses.
Nationalization differs from bankruptcy in every imaginable way.
Indeed, I fail to see how nationalization can even be accomplished in the United States, given the 5th amendment’s protections of property rights: the government would have to compensate shareholders, meaning, the government would have to purchase outstanding shares. Mankiw and others seem to think that shareholders can simply be told tro “go away.”
It seems to me that shareholders would have a claim against the government were nationalization actually attempted.
whitetower,
I suggest you familiarize yourself with bank regulation before voicing opinions on what is permissible and not permissible.
Regulators can seize a bank any time they feel like it, and management and shareholders have no recourse. That is the nature of the arrangement if you have a bank charter. If you don’t like it, don’t become a bank.
…the bank is reprivatized by the very act of awarding the equity to the former creditors.
Where is the bank going to get capital to operate?
I forgot to add: shareholders have in the past been successful in such claims against the FDIC/feds, as evidenced by the successful claim by shareholders of the First City Bancorporation of Texas that resulted in a $145 million award to them by the FDIC in 1993.
Use current laws: (1)FDIC seizure of commercial bank subsidiary with ordinary depositor FDIC insurance and Chapter 11 for the holding company. (2) But this time–in contrast to Lehman and AIG–make it abundantly clear that there will be no bail-out. (3)Prior to the announcement, require a full independent financial audit by auditors who have had no long term ties to the company and publish their findings.
The purpose of (3) is to reduce the outright mendacity in financial statements a la Lehman. The purpose of (2) is to let counterparties and broker-dealer relationships unwind and to give bondholders the opportunity to adjust their bids to expected recovery levels, so if they are stuck holding bank debt in Chapter 11, it is not from a fantasy about inflated values due to a forthcoming bail-out (in contrast to Lehman). The policy failure with Lehman was not allowing the bankruptcy, but giving the market clear signals that it may not be allowed to happen.
American Economists: I truly had no idea how mediocre this group of people were. The crisis has ripped the roof off. My six month grand tour of their writings has been a revelation. My god, they’ve even got problems with basic reasoning ability.
As disciplines go, my view would be that in Arts and Film, in Technology, in Architecture–just to name a few–the maturity level and the creativity is miles ahead on a comparative basis to American economists. This is truly stunning.
Mankiw’s writings are those of a person barely even in touch with current conditions. The saddest are those, however, who actually use these people as authorities.
Bankruptcy could become, in effect, a massive bank recapitalization. Essentially, the equity holders are told, “Go away, you have been zeroed out.” The debt holders are told, “Congratulations, you are the new equity holders.” Suddenly, these financial organizations have a lot more equity capital and not a shred of debt! And all done without a penny of taxpayer money!
It’s a stunning paragraph, that’s for sure. Suitable for framing. He is basically saying the problem of insolvency is resolved by wiping out the common equity. I had to read his whole blog post several times just to make sure. When people like Mankiw are respected economists, is it any wonder what the country has come to?