What to do with nationalised banks?

by John Quiggin on January 19, 2009

All reasonableTM commentators now agree that nationalisation of big banks like Citigroup, Bank of America and Royal Bank of Scotland must take place soon, explicitly or otherwise. As I said at just before the second (failed) Citigroup bailout) banks like Citi are not only too big to fail, they’re too big to rescue with any of the half-measures that have been tried so far.

It’s obvious that “If it were done when ‘tis done, then ‘twere well It were done quickly” and cleanly, without any dodges designed to hide the reality of nationalisation. The longer these zombie institutions are allowed to run on public money, but under the existing discredited managers, legally answerable to the private shareholders, the bigger the costs the public will ultimately face.

Nationalisation would resolve a lot of the difficult questions around ideas such as the creation of a “bad bank” to hold all the toxic assets accumulated during the boom. That’s critical as long as policy is aimed at turning the troubled banks around while keeping them private, but it’s unimportant once all the debts and assets have been taken on to the public balance sheet. Once the big banks are nationalized, the government can take its time salvaging whatever assets are still worthwhile and preparing for the reconstruction of a private banking system under a completely new system of regulation, a task that is likely to take several years.

The big question is, what should governments do with the banks once they own them? Clearly, there’s an imperative for banks to start lending again, but there is no benefit in making yet more bad loans. And, right at the moment, credit-worthy borrowers are hard to find. The immediate concern must be to ensure that commercially sound loans aren’t being constrained by the need to bolster bank balance sheets. Then, governments need to consider whether some form of support for loans, such as interest rate subsidies or guarantees (secured against assets seen as having a long-term value that exceeds their current market value) should be part of the policy response to the recession. Such policies have plenty of risk associated with them, but the risks are mitigated a bit if the guarantor and the bank owner are ultimately the same (in this case, the public).

Obviously, this is not the kind of question economists have spent a lot of time thinking about until fairly recently. I don’t imagine many of us would have expected, a year ago, to be reading the Wall Street Journal castigating Henry Paulson and the Bush Administration for the (partial) nationalisation of the Bank of America. No doubt plenty of mistakes will be made. But there is no time for leisurely reflection here. As in 1933, the next hundred days will make a big difference, one way or another.

{ 30 comments }

1

craigie 01.19.09 at 4:55 am

seems to me there’s not much wrong with a bank called the “Bank of America” being owned by America.

2

pidgas 01.19.09 at 5:17 am

@craigie: there’s a lot wrong with it. Even JBD calls for any such “nationalization” to be temporary conservatorship with automatic triggers for re-privatization

3

yabonn 01.19.09 at 9:40 am

I’m thinking these days about the view from South America or Russia. Then, they told us about the rules of the IMF/World Bank, and how this economic pain was for our own good. Now they are nationalizing. Ergo, we’ve been had.

I suppose you can’t apple/apple compare, etc, but still, I will be interesting to see how the the ’90 economics will be written down in these countries.

4

edhop 01.19.09 at 10:43 am

Not a comment, more a question – I’m just getting my head around all the financial jiggery pokery going on.

What happens to a small shareholder when the bank is nationalised? Say he/she owns 1000 quids worth of shares in a particular bank about to be nationalised? Does the government set a price that it buys all shares at? Or is all lost for the small share holder?

Many thanks for any answers!

5

dave heasman 01.19.09 at 1:47 pm

“What happens to a small shareholder when the bank is nationalised?”

Plenty of info on what happened to small shareholders of Northern Rock is available online. It seems the best move is to liquidate, sharpish.

6

MarkUp 01.19.09 at 2:48 pm

Perhaps they could be aggregated and the remains used to buy JH his new iMac [sorry, it’ll probably have to be the refurbed 20″ model…]

7

P O'Neill 01.19.09 at 4:03 pm

Plenty of info on what happened to small shareholders of Northern Rock is available online. It seems the best move is to liquidate, sharpish.

There is some upside (at a sufficiently low share price) to the inevitable litigation. The Northern Rock thing is going to take years to sort out.

8

Steve LaBonne 01.19.09 at 4:18 pm

There aren’t going to be any nationalizations in the US, there are going to be shovelfulls of taxpayer money delivered to bank shareholders under cover of some ruse such as the “bad bank”. The Obama administration has already been pretty much captured by the mouthpieces of the investor class just as, on foreign policy, it’s been captured by Clintonite hawks. While I’m certainly damn glad Obama beat McCain (I’ll take slow rot over instant catastrophe every time), I’m having trouble remembering why I cared about him getting the Dem nomination rather than Clinton.

9

jacob 01.19.09 at 4:40 pm

Pretty hard to disagree with Steve LaBonne on this one.

On the other hand, the Pete Seeger thread above inspires me to dream: “Then we’ll own those banks of marble, with a guard at every door, and we’ll share those vaults of silver that we all have sweated for.”

10

salient 01.19.09 at 5:25 pm

But there is no time for leisurely reflection here.

Indeed: we don’t have time for rational solutions. So shovelfulls (shovels full?) of unhelpful good money after bad, and years of slow recovery for the rest of us, it is.

11

roger 01.19.09 at 5:40 pm

Why nationalize? Why not use the money to simply create a national bank ex nihilo? James Galbraith has suggested something on the order of the New Deal’s Reconstruction Finance Corporation , and it seems to me this would, at a stroke, solve several problems. It is through such a vehicle that we can managed the necessary industrial bailouts, say of the auto companies. But more, this would give the Government a command and control mechanism to allocate capital to necessary enterprises that, at the moment, can’t compete for investment in the chase after high yield environment we exist in. We know that the private sphere sucks when it comes to allocating capital, spending much more on reseaching the cure for male pattern baldness, say, then for malaria. We know that the underinvestment in the infrastructure is imbricated with the underinvestment in the green technologies that are necessary to keep the world from undergoing a truly massive environmental disaster. So, a national bank is an excellent way for the State to force the private sphere to operate for the common good. To do this, one must go athwart the conventional wisdom of the neo-classical gang, but in fifty years, when it succeeds, they can write some silly book about how the “obama’ depression was aggravated by the “interference’ of the government. Right now, however, we need massive interference. Take, for instance, the bailout of the American car industry. At the moment, in Europe, cars are being sold that get twice the mileage of American cars – by American companies! Ford has produced a mass market 60 mile per gallon car, for instance. The secret is that those cars burn diesel, which is now refined in such a way that it is less polluting than gasoline. Why isn’t this happening in the States? Lack of refineries that could do the same thing. A national bank could either finance the building of those refineries or the financing of a wholly new private public entity to build them, if need be.
If the 700 billion had been put into such a bank in the first place, we’d be in a much beter positions at the moment.

12

Steve LaBonne 01.19.09 at 6:18 pm

Why isn’t this happening in the States?

You could ask that question about so very many things…

(In every case the ultimate answer will be “corrupt government and ignorant voters”.)

13

John Emerson 01.19.09 at 9:35 pm

This is American, Quiggin. The “reasonable” thing to do is obviously out of the question. In real-world, non-utopian terms, which will be the least damaging unreasonable approach?

14

JoB 01.20.09 at 12:21 pm

Split the banks in smaller units. Get their administrations to go out & convince people to put the money with them – then go out and be convinced by other people to get the money that has been put in their trust.

Let banks lend only to big institutions if they’re prepared to split into smaller units & make their administrations go out and do specific things rather than bug everybody else with bonuses & the like in order to definitely distract them from doing what they’re good at.

The only organization that is allowed to grow bigger is the UN: not in size, only in jurisdiction. I believe they should for instance be able to make it illegal to compare money for food companies and money for oil companies based on one single ratio.

How’s that for non-Utopianism?

15

Tracy W 01.20.09 at 12:58 pm

But more, this would give the Government a command and control mechanism to allocate capital to necessary enterprises that, at the moment, can’t compete for investment in the chase after high yield environment we exist in.

We already have a system for this. It’s called taxes. The government passes a law and raises taxes, and then hires people to carry out whatever necessary enterprise it wants to do. The government can hire people directly as public servants, or it can write contracts with private companies to deliver the goods, which is better I think depends on how standard the contract is – I think the government is best off just buying petrol for police cars, but hiring police as public servants makes more sense than writing contracts due to the incentives problems. This is, for example, how governments fund things like school buildings, hospital buildings, sewage systems, and military weapons.

We know that the private sphere sucks when it comes to allocating capital, spending much more on reseaching the cure for male pattern baldness, say, then for malaria.
The relevant question is does it suck more than the public sphere? Governments around the world spend far more on military weapons than on a cure for malaria. The New Zealand government’s experiments with Think Big were not pretty – lots of massive energy-intensive projects that were made massively uneconomic by the drop in oil prices, and a big hydro dam built in a nasty place from a geological viewpoint. The Japanese experience of massive construction projects does not appear to be remarkably good. The British government has just decided to build a third runway at Heathrow, there are a number of people who are convinced that this is a really bad idea. And what do the Italians think about the Italian government’s decision to reintroduce nuclear?

So, a national bank is an excellent way for the State to force the private sphere to operate for the common good.

And a national bank is an excellent way for the State to force the private sphere to operate for the current Government’s good (eg big unnecessary building projects in marginal electorates). And a national bank is also an excellent way for one powerful Minister to force the private sphere to operate on the basis of whatever weird ideas he or she gets.

16

Steve LaBonne 01.20.09 at 2:19 pm

And a national bank is an excellent way for the State to force the private sphere to operate for the current Government’s good (eg big unnecessary building projects in marginal electorates).

That might be a refreshing change from the usual American practice of letting the private sector force the government to operate for the overclass’s good.

17

roger 01.20.09 at 6:18 pm

Tracy, who doubts that command and control systems decay? The question of which is best ignores the fact that there is a business cycle, and that different approaches are fit for different moments in the cycle. The big “unnecessary” state projects in the U.S. happened to create the American west – without the government in effect taking over the water of the land West of the Rockies, there would certainly be no Los Angeles, Arizona would have 200 thousand citizens, Washington and Oregon would still be mostly trees. There is an environmental perspective in which, perhaps, that would be to the good – but it certainly isn’t a capitalist perspective.

The state, of course, has many of the same structural faults as the private sector – namely, its vulnerability to oligarchic capture. We are watching a spectacular oligarcho-fest unfold before our eyes, as the Government which is supposedly worried about whether it can pay the medicare bills of the sick in 2040 slings trillions of dollars at the banks in a matter of six months. And you are correct that the best way to correct this situation is to destroy, to the extent that is possible, the entrenchment of the oligarchy through taxes. A marginal tax rate on incomes above of million per year of at least 70 percent would be an awful big help – and more, an inventive way of breaking up the wealth of the wealthiest, which is not income wealth, would also be a help. The more entrenched that wealth is, the more the private sector tends towards dysfunction, resulting in the hunt for high yield that gives us ‘cures’ for risky securitized commercial real estate mortgages instead of cures for malaria. Of course, the golden era of medicine, the fifties and the sixties, the anti-biotic revolution, was the direct result of state intervention. Penicillin production was funded during WWII by the state, the great pain relievers, like Cortisone, came out of military funding, the surgical procedures that resulted, eventually, in transplants again came out of state funding for military purposes, it was public health measures by the state that first brought down tb, etc., etc. Find a major disease, find the cure, and you will find research money traced back through publicly funded programs at universities, and national health care agencies, that were at the back of it. But this system also displays exactly what can go wrong with the state – the Bush pill bill, for instance, massively rewards inefficiency in Big Pharma and maintains the crazy IP system that makes health care costs go up when technology gets better – in opposition to, say, software. Healthcare that should be cheaper and cheaper is more and more expensive because of the entanglement of state and private interests.

To return to the argument, however – the conservative use of the term “crowding out” interests me, because what has been crowded out, for the past thirty years, is public investment. It has been crowded out in the name of the more “efficient” private sphere, but the standard of efficiency seems to be skewed – it isn’t more efficient at meeting mass needs for better education, cheaper healthcare, a cleaner environment. And when taking up the challenge of expanding housing, the private sector showed consclusively that it couldn’t do it. It couldn’t do it, that is, efficiently – because at the same time that the private sector was expanding credit, it was battering down the bargaining power of labor, and thus lowering the rate of increase of household income, or freezing it altogether. The private sector can’t insure retirement – the Chilean experiment, right now, the one that Bush’s privatization program was based on, is in freefall. And all the countries that followed Chile’s lead are watching as a generation’s pensions disappear. The business cycle will turn, and the private sector will eventually digest the programs laid down by the state again – but in this trough, it is time for the state to expand massively.

18

virgil xenophon 01.20.09 at 6:23 pm

salient:

LOL. You make a “salient” point about “shovelfulls”–which is the way most of us admittedly orally pronounce it, and the more grammatically correct “shovels-full” which
far fewer people use today–another indicator of our collective slide into linguistic sloth.

19

MarkUp 01.20.09 at 7:17 pm

”There is an environmental perspective in which, perhaps, that would be to the good – but it certainly isn’t a capitalist perspective.”

As the old saying goes, “man does not live on melamine alone.” If it’s just a capitalist story we seek why not just sell to the house of Saud or Dubai or China, after all we have squeezed most of the stuffing out? Seems you’re measuring success in a similar manner to how The Surge is being portrayed, or in light of todays events like how the transfer of governmental power[s] did not involve a coup.

20

roger 01.20.09 at 7:35 pm

Markup, I’m not sure I understand what you are saying. The surge comparison seems to imply that you support unilateral withdrawal from California, Arizona, Nevada, etc. Now, it is true the the private sector is doing a heckuva job withdrawing from Las Vegas – after making it a million plus city, it is rapidly tailspinning back to the old watering hole for drunks it is supposed to be. On the other hand, I don’t see the private sector pitching in with a collective sigh of, well, it might be totally unprofitable, but we are going to scrap every environmental negative externality and prepare for the sixty year drought cycle that the West is apparently in. If you see signs of that behavior, let me know.

21

MarkUp 01.20.09 at 8:25 pm

”I don’t see the private sector pitching in with a collective sigh of, well, it might be totally unprofitable, but we are going to scrap every environmental negative externality and prepare for the sixty year drought cycle that the West is apparently in.”

Are you looking for that Roger? There seems to always be money in the public well. My point was in your separating, “environmental perspective” and “capitalist perspective.’’ That P~P dis-entanglement is readily apparent ‘out west’ and amounts to US cleaning up the mess be it a more singular externality like the Berkley Pit or a broader one, say, lack of salmon in the Sacramento river basin. I don’t believe that’s what you’re really trying to argue but it was none to clear to me in thta passing of phrase.

22

roger 01.20.09 at 9:33 pm

Now, I’m not looking for the state to become the salvation army. In fact, as any reader of Cadillac Desert knows, our environmental crisis is in many ways a product of state intervention. My point is simply that the state must also be the instrument that corrects, as far as that is possible, those crimes against the environment. Jeffrey Sachs – I know this via Mark Thoma – has suggested that the auto industry needs state backing to produce a reasonably green vehicle. I think that is true. Now, you might think a better solution is to so underfund the roads and highways so that they are unuseable. But I don’t think that is realistic. In truth, we have and will have a mixed economy. The right that kicks against a national bank is more than happy to let the state, for inIstance, seize monopoly control over the air waves – how else will it get its Rush without piratte radio interference? Or to build new highways. I assume a non-revolutionary context in which these are given factors, and then ask what stretegy would bring about a better environmental outcome. As it happens, this outcome will be as much of an economic multiplier as the first generation of state interference that engineered the mississippi – a Hoover project – and dammed the western rivers.

23

MarkUp 01.20.09 at 10:22 pm

The “state” is but a reflection of [some portion of] the inhabitants. The “need” of the auto industry is an orchestrated one, much like the “surge,” and is a similar need to say the CAP. It may “work,” but is it a solution? A few simple regulations is what they really need. They are not there as a public service, however the roads we all pay for are, and do indeed amount to a subsidy for them – and yes they do need to be smooth lest my Hummer handles poorly.

24

roger 01.20.09 at 11:33 pm

Mark, I don’t understand your language. The auto industry has been orchestrated since 1900 – which is when Congress passed large tariffs on imported automobiles to nourish an American automobile industry. It only “worked” for a century, but was it a “solution”? If, by solution, you mean a policy that will last for a geological epoch, no, it won’t “work” – it will only be another “solution”. Any action whatsoever by the “state” in a “democratic” state will probably be the result of “orchestration” – alas, the people’s will doesn’t work “spontaneously in the “United” “States”. There is a “solution” to that – Maoism. A simple spontaenous ‘state” policies that emerge from the “head” of the great Helmsman.
Otherwise, though, we are in a subgenius world, where all is “faction” and “orchestration”. You might be shocked to discover we have something in this country called a “corporation” which “orchestrates” the productive power of the worker and gives the [some portion] of it to a group of lazy wankers – called “upper” “management”.

Horrid, but true! Google it.

25

MarkUp 01.21.09 at 12:25 am

Of course Maoism isn’t the only answer is it nor were the solutions graced upon us by Congress via the corporate Helmsmen at the time, or even now. Juging by the pace of the trillions that have gone to support finance industry our economy, spontaenous ‘state” policies do seem possible. Are we now Mao, and are you “upper” “management”?

26

roger 01.21.09 at 5:21 am

Having chased each other around the pole a few times, we meet again! – I totally agree about the bailout. Hence, my suggestion that the money should have been used to capitalize a national bank, instead of being poured into the impossible task of recapitalizing a shrinking financial sector. The latter, of course, makes no sense – as the financial sector didn ‘t collapse do to some repairable bank error. Eight years of stagnating or depressed wages for the majority of people in this country meant that lifestyles were being maintained on plastic tat from China and credit. Pouring money into the coffers of the creditors is going to do nothing about the fundamental structural situation. A solvent bank in a wasteland is simply a monument to perverse incentives and the inverted mindset of the free markets crowd. Since the only solution is long term, involving wages that go up and unemployment that goes down, finance manufacturing and commerce and be damned to the rest. The financial sector might not be as important as it was for the next fifty years, or ever. The money being poured into it will never come back – after all, if you forced the banks to pay it back, you’d defeat the purpose of “loaning” it. Thus, I’d guess we conservatively have already lost a trillion, despite the assurances that these are just tidy over loans. No, c’est fini. Now we will endure a year of oligarchical denial.

27

MJJP 01.21.09 at 11:02 am

There are very few state(nationalized) owned banks that are profitable. Whats the point?

28

JoB 01.21.09 at 12:14 pm

MJJP, whenever a bank makes profit it is privatized to make the few happier, whenever a bank makes a loss the few are bailed out by all of us. So – what’s your argument?

29

Eric Fowler 01.22.09 at 6:25 am

We live in mad times, or we would not even be talking about such things.

Considering it is all heading south anyway, isn’t it a pity that we missed the opportunity to build a sound currency? A few posters back someone said we might have at one point used all the billions we are pouring into private banks to make a government bank and let the private banks fail. Maybe we could have (or could still) created a sound dollar and done away with the Federal Reserve.

Eric

30

MarkUp 01.22.09 at 10:30 pm

David Cay Johnston has been appointed as Second US Assistant Secretary of Defense for Econoterrorism Activities and Recapturement [ASDEAR2US]. Word on the street is a simultaneous invasion of the Caymans and Bermuda. One source says this war will pay for itself.

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