Making the revolution permanent?

by Henry Farrell on October 10, 2008

I suggested a couple of days ago that the partial nationalizations of national banking systems that we’re seeing 1 was likely to be a temporary phenomenon, albeit one with long lasting implications for market actors’ expectations. I’m beginning to have second thoughts; I now suspect for two reasons that bank nationalization may be a lot harder to reverse than I thought.

First is the move towards more or less complete deposit guarantees that many Western states are offering (most explicitly Ireland, less explicitly the UK, Germany and others). This is a move that is going to be hard to undo any time soon without risking a further grave crisis of confidence. But it is also one that exposes taxpayers to risks that are far greater and difficult to quantify than the previous system (where many or most advanced industrialized states guaranteed deposits up to a set figure). The moral hazard problems are obvious, and states will want to have as many tools of control to make sure that they don’t get taken for a ride. Large stakes in the relevant firms are one such means of control.

Second – historical institutionalists in political science (Paul Pierson, Jacob Hacker, Kathleen Thelen etc) talk a lot about the importance of sequencing and timing in explaining institutional change. Their arguments might lead one to break up the responses to the crisis into two phases, one of which is likely to build on the other. The first phase is the current one – trying desperately to stop the entire system from breaking down through a variety of measures including injections of liquidity, interest rate cuts, and, most prominently, taking stakes in banks and other financial institutions. The second phase hasn’t really started yet, but will involve trying to build longer term institutions at the domestic level, and (to the extent that agreement is possible), the international level too to prevent this kind of thing from happening again.

The key point here is that the second phase isn’t going to begin _ex nihilo_; instead, it’s going to begin in a world that has been reshaped by the emergency measures that are being taken at the moment. And these measures will offer a set of possible tools and means of influence for government that will prominently include use of governments’ ownership stakes in large chunks of the financial system. It will be very tempting indeed for governments that want to secure financial stability to take up these tools and make them part of their permanent apparatus. Nor do the free marketeers seem in a very good position to win the ideological fight against this kind of initiative given their current disarray. Although the _Economist_ and other stalwarts are bravely battling on, “as Dani Rodrik notes”:, Samuel Brittan of all people has “declared himself today”: to be a closet Keynesian and is pushing the case for an expansionary fiscal policy.

1 Or, in Iceland’s case, full nationalization; see also “Paul de Grauwe”: in the FT this morning for a more general full nationalization proposal.



someguy 10.10.08 at 5:13 pm

Matthew Yglesias had the funniest response.

We have all these bad loans that were made in part based on well intentioned government pressure in the name of “socially responsible” policies.

As a result the government now owns all these fiancial institutions.

Matthew Yglesias thought we should think about what “socially responsible” policies the government should pursue via it’s newly owned fiancially institutions.

I mean I just don’t get it. You think, hey, Without any ownership government pressure played an important role in the current disaster, why oh why would we ever permanently nationalize these institutions?, is some kind of unwinnable argument?

Easy money and the desire to use any and all vehicles to redistribute are part of what has brought us here. The failings of progessive ideology.

Now yeah we can say the same about the total lack of regulation of investment banks and free market ideology. Maybe that was the bigger failing. Plenty of very free market inclined folks seem to think so.

No general POV has really been vindicated or discredited.


Luis Enrique 10.10.08 at 5:42 pm

Which chunks of the financial sector do you see potentially remaining within the state? If you mean broad functions like business lending and corporate finance, for example, then I don’t think it’s only stalwart free market ideologues who would argue a market is likely to do better (to be ‘freer and flexible’ – in a good way – as opposed to ‘heavy handed’ government provision, as the Economist has it). But perhaps that’s not what you have in mind at all, and you are thinking of some narrow functions, say, debt default insurance or some such (is that what De Long means here?, in which case the free marketeers are probably on much shakier ground as you suggest – but that sort of thing can sit pretty happily with a sensible free marketeer’s world view (as De Long points out, heavy state involvement in finance as been accepted by all for ages. See here – for quotes from the original Economist editorial position – Bagehot – and come to think of it, Friedman, on financial bubbles and the need for government intervention)

But was that Economist article “bravely battling on” against the idea of a long term government role in certain areas of the finance sector, or in the broader economy? If the latter, Rodrik may call a general preference for markets ‘ideology’, others would call it a position that is pretty well empirical supported (with, of course, some important exceptions).

(And is it really surprising that Brittan supports expansionary fiscal policy in these circumstances? that last comment gives me the impression that you see Brittan and perhaps other people you think of as ‘free marketeers’ – The Economist for one – as more one-dimensional and blind to context than they really are) .


sg 10.10.08 at 7:23 pm

John, you say in your first paragraph that the moral hazard problems of governments protecting deposits are “obvious”. Given I cannot function in the modern world without a bank account, and given my savings earn less than inflation, what is the “moral hazard” of my savings being protected by the government? Was it somehow wrong of me to lend my money at less than inflationary rates to a bank, so it was safe from robbery? Should I have invested my monthly pay packets in gold, and damn my eyes for the risk-taking temerity of putting it into a bank? Or is there something in that paragraph I’m missing?


noen 10.10.08 at 7:34 pm

Former Goldman Sachs CEO (and current US Treasury Secretary) Henry Paulson, said that he expects to “nationalize” Goldman Sachs and Morgan Stanley before the weekend is over. Oh wait, that should be Comrade Henry Paulson, sorry.


ingrid robeyns 10.10.08 at 7:40 pm

Henry, thanks, interesting thoughts.
A question: can’t it be the case that whether or not nationalisation will be permanent or not will differ from country to country? The case of Iceland seems to be so bad because of features of that particular country’s economy, which are not shared to the same extent (as far as I can tell) by some other smaller European countries (particular credit habits, importance of the banking sector in GDP etc). The Dutch government has made 20 billion Euros available for loans to Dutch banks (20 billion on a population of 16 million people), and has bought the Dutch part of the international bank Fortis (Belgium and Luxembourg are left with the other parts), but I don’t think anyone believes the Dutch government will (want to) keep that bank, nor will it have to once inter-bank trust is restored. Your thoughts make sense to me, yet spontaneously I would also think that whether nationalisation will turn out permanent may differ between countries. But then, would it be possible to have a one-currency (e.g. Euro) financial system whereby some banking sectors are quasi-nationalised while others are not?


lemuel pitkin 10.10.08 at 7:59 pm

The de Grauwe article is very interesting. but of course, like everyone talking about nationalization, he ends by saying: And then we privatize the banks again. No one ever feels the need to justify that last step.

(That we should eventually re-privatize (all) the banks is even more non-obvious when you think not only of the crisis when the bubble bursts, but the mis-allocation of capital while it expands.)


John Quiggin 10.10.08 at 8:03 pm

Lemuel, at this point I think the eventual reprivatisation is more in the nature of a pious hope than a serious part of the plan. It certainly makes it a lot easier for the Financial Times (!) to advocate that most of its readers should become government employees if they are assured that this is only until the emergency is over.


tps12 10.10.08 at 8:05 pm

We have all these bad loans that were made in part based on well intentioned government pressure in the name of “socially responsible” policies.

Not actually true, is it.


Odm 10.10.08 at 8:37 pm

So far as I understand, the Fed’s role in the crisis was keeping interest rates low and refusing to examine risky practices like debt securitization, and the Fed in turn was pressured by an administration encouraging home ownership.


someguy 10.10.08 at 9:08 pm


If it isn’t true it wasn’t from a lack of effort. (and it certainly appears to be at least in part true.)

Now maybe the banks would have made all those bad loans with or without that effort. Fair enough. Lets say that is true.

Now what if the banks had been owned by bunch of those well intentioned folks who were demanding all those loans?

Well intentioned folk who were more concerned with promoting “socially responsible” policies than profit.

A bit of a recipe for disaster, isn’t it?

Or try this thought –

Imagine if GWB and co had been in charge of the finance sector for the last 8 years?


MarkUp 10.10.08 at 10:34 pm

”A bit of a recipe for disaster, isn’t it?”

Would they have made loans that any semi-prudent loan officer would assume would have a high rate of default, and then use the process to aid in concealing that risk? Or perhaps, would they have been more “honorable”? I know both credit unions we bank with are quite healthy and did and do make loans in areas / for folks generally considered in the higher risk category, just not with high risk pump and dump instruments designed only for max commission and fee generation.


Canadian 10.11.08 at 12:11 am

A pyrrhic victory? Banks failed because they could’nt cope with the difficult economic conditions. Governments take them over. Now governments have to allocate capital to different sectors of the economy. As commentators here already make clear, there are a lot more demands on that capital other than profit maximization. The history of nationalizations is not promising. My cheap predictions is that governments will fall more often. Can I bet on it?


Walt 10.11.08 at 3:31 am

someguy, the policies you mention are not an important cause of the crisis, no matter how many times Sean Hannity says otherwise.


virgil xenophon 10.11.08 at 8:27 am


No, hubris and greed were the proximate causes–but the distal cause that set the whole
train of events in motion and created the psychological predicate necessary to inculcate
an entire generation of people in the financial industry in the belief that the “sub-prime” mortgage mkt was an acceptable sandbox not only to play in, but to vastly enlarge to accommodate the rest of the public–originated in Congress and Congress alone.


Martin Bento 10.11.08 at 8:55 am

To elaborate on Walt’s point: the crisis came about because of a faulty assumption of endlessly-rising home prices, and a series of mortgage “innovations” that fall chiefly into two categories:

1) accepting undocumented assertions from borrowers about their financial situation. These are the so-called “stateds” – stated income, stated asset, even stated (fact of) employment. In all cases, the lack of documentation was paid for with a hit to the interest rate that was presumed to cover the increased risk of default. What happened, of course, is that buyers lied. These, then, would not count towards any government program or “encouragement” to lend to low-income buyers, as these buyers were not, on paper, low-income, though they sometimes were in actuality.

2) Various schemes that made payments escalate over time and/or kept the principle unpaid: adjustable rates, interest-only, balloons, neg ams, all that stuff. All of this stuff would normally be considered exploitative of low-income buyers, and I would like to see documentation that any government program encouraged this. These schemes are also, sans unanticipated rates of default, wildly profitable for lenders, which strongly suffices for an explanation – government interference is a wholly superfluous postulate, so Occam slices it away. Also, these loans were also often stateds.


a different chris 10.11.08 at 1:34 pm

>Not actually true, is it.

Tiresome, isn’t it.

Well, the good thing about the internets is that we get to see these right-wing myths created in real time, so we aren’t as gobsmacked when we see them prattled about among otherwise decent but clueless co-workers.

The data has been sliced, diced, cooked and served, and still they ignore it for the quick fill of empty calories.


a different chris 10.11.08 at 1:37 pm

Crap, I meant to add:

“Don’t let the trolls drive this thread off-subject”.

But apparently they succeeded with me. Sigh.


someguy 10.11.08 at 3:17 pm

I don’t watch Hannity.

I have already happily conceded that perhaps Frank’s cheer leading for bad loans has absolutely nothing to do with the current crisis. That absent that cheer leading all those bad loans would have been made.

That the repackeging of these loans for and buy investment banks creating widespread but opaque risk was the bigger problem.

Though I would like to note without that problem, we might not be talking about recssion vs depression, but we would still would be on the hook for 100s of billions in bad loans and a potential depression.

But even if no part of the bad loans resulted from government pressure, an extremely dubious assumption, that wasn’t from a lack of effort. Certainly nothing was done by Frank and Dodd, responsible for oversight, to prevent 100s of billions in bad loans.

But appearently suggesting that giving more control to those folks, the folks demanding more bad loans, isn’t a panacea is trolling. That pointing out that sometimes well intentioned progessive policies can have disaster consequences is trolling.

At least the private actors who got us into this mess will make few millions less. At least they are generally despised.

Frank and Dodd are completely untouchable. The mess they presided over stinks up the whole room but it cannot even be mentioned because to do so would cast doubts on the ideological panaceas being offered up.


someguy 10.11.08 at 3:18 pm

potential recession.


Martin Bento 10.11.08 at 5:15 pm

someguy, it is also quite clear that the bulk of the loans recently failed were made before January 2007 when the Democrats became the majority. Very few, if any, adjustable loans made since that time will have begun to escalate yet. It is true that we have not seen new legislation to deal with all this till recently, though there seems little reason to suppose any would have survived either Senate filibuster or Presidential veto, and within the framework of the existing law, Frank and Dodd were quite constrained. It is true that both parties have strong links to Fannie and Freddie, but it is false that Fannie and Freddie are the bulk, much less ultimate cause, of the problem: though between them, they buy the majority of mortgages in the country, they don’t buy the majority of subprimes (less than 10% of Fannie’s portfolio, last I checked), and they never bought the real junk (like neg ams).


J Thomas 10.13.08 at 12:13 am

That pointing out that sometimes well intentioned progessive policies can have disaster consequences is trolling.

This is the Bush administration we’re talking about. Well intentioned progressive policies? Not likely.

The Bush administration had a serious balance of trade issue. They needed somebody to loan the USA money, and what foreigners particularly wanted was risk-free loans. Foreigners believed mortgages were risk-free, so the Bush administration gave them more and more mortgages. They pumped up the price of existing mortgages, and created as many new mortgages as they could. When they ran out of plausible citizens to get mortgages they went for implausible ones and eventually the whole thing blew up.

Do you seriously imagine they did it because they wanted US citizens to own homes? No way. They wanted to sell mortgages to china, so they needed mortgages they could sell to china. Nothing progressive or well-intentioned there except as part of the smokescreen.


engels 10.13.08 at 12:41 am

sometimes well intentioned progessive policies can have disaster consequences

Sometimes not-very-well-intentioned policies can also have disastrous consequences. Go figure.

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