Non-Sequitur Objections to Bank Nationalization
William Isaac has a Wall Street Journal op-ed claiming that his experience at the FDIC during the time when Continental Illinois was taken into receivership has given him important insights into why we shouldn’t use nationalization as a solution to the problems of today’s large banks. The op-ed doesn’t, however, really do that. Instead, it just repeats a couple of common instances of argumentative ping-pong. One sequence goes like this:
- Me: The FDIC nationalization process works well for dealing with small insolvent banks, so faced with a large insolvent bank we should do something similar.
- Isaac: But we’re talking about much bigger banks, it’s a different situation!
The other goes:
- Me: A nationalization process worked well for Sweden in the early 1990s, so faced with a similar banking crisis we should do something similar.
- Isaac: But we’re talking about a much bigger country, it’s a different situation!
In both cases, it’s true, the scale is different. But you have to consider why nationalization is the appropriate response in other situations. The issue is that there are only really two other alternatives. One is that you can let the bank go under, thus ensuring that everyone to whom the bank owes money loses out and setting off a panic that paralyzes your financial system. The other is that you can just give free money to the bank, thus rewarding the managers and equity holders whose poor business decisions created the situation. Neither of those is a very appealing option. Thus, nationalization. Nothing about the banks in question being big, or about the United States being a large country, change the fact that the other options are bad. Isaac offers this alternative prescription:
The Obama administration should declare that nationalization of any major bank is off the table; that the government stands behind our entire banking system; and that our banks will continue to receive a nonvoting form of equity capital, such as convertible preferred stock, from the government to the extent needed. Yesterday’s joint announcement to this effect by the Federal Reserve, FDIC, the Comptroller of the Currency, and the Treasury is a critical step toward healing our banking system and economy. Well done.
This is the “free money” option. And while it’s true that our only examples of successful nationalization schemes come from much smaller countries, we do have an example from the world’s second-largest economy of what happens when you try to go down this road. It’s Japan in the 1990s and it didn’t work. Now it’s true that the fact that the alternative to nationalization failed in a large economy doesn’t prove that nationalization will work. In theory, it could just be the case that we’re screwed and that there’s no way for a large economy that runs into this problem to rescue itself absent decades of suffering. But it’s also possible that what’s been made to work in small countries can be made to work in large ones. And as Kevin Drum says, it’s not as if the government would be restaffing Citi and Bank of America de novo. By and large, the very people working at those banks today would keep on working there. Some senior managers would get fired. But the big difference is simply that you would create a situation where a robust bailout of the institutions doesn’t end up rewarding the existing shareholders and senior managers. Then you could do the bailout and refloat the bank to private investors. It’s not about having the government “run” the bank, it’s about making sure that bailouts don’t reward the wrong people.
27 Responses to “Non-Sequitur Objections to Bank Nationalization”
Register
RSSLogin
Topic Cloud
ArchivesBlog RollAbout Matt YglesiasContact Me
Donate
February 24th, 2009 at 6:29 pm
Over in Megan-land I’ve just commented that we should consider drawing a distinction between the banks as institutions, and their personnel. Much of the visceral distaste for the free-money option is because it rewards the individuals who made the disastrous decisions; if we had a way to bar those people from continued employment in the financial sector, through some like of lustration process (to borrow the term for the post-communist vetting process in Eastern Europe) that few would successfully get through, we could take a deep breath and decide what to do based on what’s best for the economy as a whole, without worrying about the wrong people being thrown a lifeline. As it stands now, my default option is nationalization largely because the continued management of failing banks by the people whose venality and incompetence made them fail (dragging the world economy down with them) is intolerable.
February 24th, 2009 at 6:57 pm
That seems like reverse Communism: corporations own the government!
February 24th, 2009 at 6:58 pm
It’s way too close to spring to be setting money on fire.
The people running these banks have incentivized long-term loss for short-term gain (and they’re not even gaining in the short term!) through their salary and bonus structures. We AT LEAST need new salary and bonus structures, and it may as well be the government that makes them–the other option is that the Boards make them, except that the Board of Citi is made up of the upper execs from BoA and Chase, so we can’t trust them.
On a side note, I was listening to Diane Rhiems (I hold her in too much contempt to look up her last name) hold a round table with somebody from Heritage, somebody from Cato, and an investment banker from Brookings. Shockingly, the full-spectrum consensus was that receivership would make the moon fall to the earth.
February 24th, 2009 at 7:00 pm
Well he had to come up with something and killing every major liberal, as defined my him, and taking away all appropriation , and monetary authority from congress and putting it in the hands of a New Treasury, Goldman Sachs, is a bit too gauche, right now.
February 24th, 2009 at 7:01 pm
There is also a huge myth flying around that if banks are “nationalized” (taken into receivership) then their employees will become government employees (and that, of course, is pure evil). But of course all government ownership means is that the government owns the company–it can make management decisions, but the company is still run by its own management, and employee salaries come out of the company’s coffers, which in this case would be supplemented by additional shareholder (in this case, government) investment. We’re not going to suddenly reset the pay rates of every single employee; we’re simply going to make these companies accountable to their major shareholders, namely the American people.
February 24th, 2009 at 7:11 pm
I haven’t actually read the article or anything, but as summarized here, Isaac’s second response cancels out his first response, doesn’t it? That is, the banks are bigger than in the other case, and the nation in which they exist is bigger too.
February 24th, 2009 at 7:11 pm
Oh for italics’ sake….
February 24th, 2009 at 7:22 pm
Well, if you have to nationalize a really big bank, you should make sure and do it with really big people.
February 24th, 2009 at 7:37 pm
William Isaac has a Wall Street Journal op-ed…
I’m shocked that the head of a firm that sells consulting services to bond holders would oppose bank nationalization — simply shocked.
February 24th, 2009 at 7:55 pm
I must disagree with Matt’s analysis, which, in this case, I think is shallow and not well thought out.
I think Luke makes a very valid point and one that nobody seems to be addressing. As I’ve said before, the root cause of the problems faced by the Swedish banking system was far different from what I think is the root cause of our current financial meltdown, namely, the culture of excessive risk taking engendered by the excesses of American banks executive compensation systems and our peculiar approach to corporate governance in which stockholders have little or no say over how much their “employees” are paid. Basically, these “masters of the universe” enriched themselves by being in control of a vast pool of “other people’s money” (“OPM”). The pool of money was so large that they could gamble recklessly. If they won, they paid themselves lavishly and took a king’s ransom as “bonuses”. If they lost, however, they themselves typically lost little and (as we’ve seen at MLPFS, for example) are able to bleed enough from these failing banks to make themselves vastly wealthy.
The current proposals seem to imply that removing a “few managers” will be enough to change an entire culture of corporate compensation which is well entrenched. How so? ? After all, isn’t a blank check drawn against the US Treasury the ultimate pool of OPM? Absent truly significant governmental management in the operations and compensation (bonus) decisions, the same group of managers will simply play musical chairs (rather like managers in major league baseball) as they control “nationalized” banks which are still largely unregulated, highly leveraged, and where they CEO’s and others are paid on the basis of “earnings” which are easy to manipulate or on the basis of the amount of the banks’ value.
Since the bank executives are gambling not with their money but with the taxpayers’ money, why wouldn’t they continue to spend like, well, like CEO’s and reward themselves lavishly until the banks were “re-privatized” in which case they would be free to repeat the entire cycle once again.
Which, of course, leads me to ask anonymous at (8) to explain exactly how he proposes to make bank executives “accountable”?
February 24th, 2009 at 8:20 pm
DTM,
I don’t think it would be wise for the taxpayers to own 50% or more of one of these banks and not vote their shares. What do you do at bonus time? How do you get rid of the corporate jets, the Superbowl parties, the $16K trash baskets, the $6K shower curtains and the whole culture of corporate greed that sunk these companies in the first place?
The same people who gambled away their companies (but kept their own money safe) will simply go back into the casino and double up using the Treasury’s money. And then, when we once more find ourselves in this same situation, to protect the financial system and our investment, we’ll have to bail them out again.
I do not see how the nationalization of private banks and financial firms will solve the problem. On the contrary, it will simply give the bankers a bigger pot of OPM to steal from.
I suggest that what is needed is a plan similar to the Chrysler Bailout in which the Carter administration refused to simply hand over the money but instead required sacrifices and changes by everybody with an interest in saving the company: management, stockholders, investment bankers and others. And the taxpayers got most, if not all, of their money back in the end.
I continue to believe there must be changes made and sacrifices borne by the people at the top who caused this mess in the first place. “Nationalization” is a word, not a plan.
February 24th, 2009 at 8:54 pm
DTM,
But it really is a bottomless pot of free money and the bankers really are free (and highly incentivized) to leverage up and go right back into the casino. How do you plan to stop them, exactly? The same way the government stopped the ML executives from awarding themselves massive bonuses? Or maybe we could do it the way we stopped AIG from squandering our money and even paying multi-million dollar ”retention bonuses” to the unit that actually turns out to have sunk a trillion dollar company?
The Obama Administration hasn’t tried in any way to limit or reduce the “zombie companies” from paying absurd bonuses and showering their CEO’s and senior employees with lavish perks. Neither has Obama made even the slightest effort to claw back any of the money that was taken from these federally subsidized companies. I don’t think it enough to toss out something like “we have the power to impose pretty much whatever regulations and oversight we want on banks, voting shares or not, so this actually becomes a somewhat complicated question of how much control we want to exercise and in what way.” This kind of throw-away line is all I’ve heard from proponents of nationalization.
“Nationalization” in the absence of highly active management and regulation is simply making a limitless gift to whoever ends up running these banks. So, yes, it really can be free money and it’s there for the taking by whoever runs the banks. Again, “nationalization” is a word, not a plan. What’s the plan? How does guarantee that the bankers won’t steal from the government like they did from their shareholders? I would suggest that seeing an actual plan is important in deciding whether this is a wise course of action.
February 24th, 2009 at 9:21 pm
C has $800 billion in SIV’s off the balance sheet. That is where they will stay. Same for the trillions in level 3 assets of all the big banks. By allowing trillions to go off balance sheet in the first place the Fed nationalized the banks, if you want to apply one of the dozens of possible definitions of nationalization.
The term nationalization is without objective meaning. A semantic puzzle. Nationalization is in the eyes of the beholder. For all practical purposes nationalization would mean that trillions in losses would be recognized and taken. Which might seem counter intuitive but that is how the big money is now referring to it. Capital will be preserved at the expense of the Treasury and that isn’t nationalization. I know it makes no sense but trust me.
The Fed is finally starting to settle on the first $50 billion of the trillion in MBS paper they are going to buy at non market prices, with money they are printing. Thank God we don’t have socialism in this country and never will. Praise be the free market. Socialism being putting money in the hands of a person with no capital who works for wages.
If that printing can offset the massive Treasury supply, $124 billion this week, is open to question.
February 24th, 2009 at 10:10 pm
In both cases, it’s true, the scale is different. But you have to consider why nationalization is the appropriate response in other situations.
But the scale isn’t different, Matthew. I just spent a coupla of hours digging for the relative scale of the takeover, and it turns out that in the Scandinavian banking crises, the Norweigans took control of banks that in turn controlled 85% of assets in the system (total system deposits were equal to 55% of GDP), Finland took 31% of assets under control (total deposits, 52% of GDP) and Sweden took 22% of assets under control (total deposits 40% of GDP).
The US on the other hand, has total deposits equal to 72% of GDP. (Note: we have a higher public debt to GDP ration (39%) than any of those other countries, the highest being Norway with a ratio of 28%.) At any rate, it is correct that the banking system is (in terms relative to the size of the US) larger than it was in the Scandinavian countries – that just means we’re in worse trouble. However, the percentage of the banking system that was nationalized varied in all three Scandinavian countries, but that had no impact on the outcome. The Swedes only wound up controlling 22% of system deposits, but 70% of system deposits were actually in trouble. They got by without going whole hog. But that’s mostly because their banking system had not got itself in near as much trouble as it had in Finland and Norway.
As I’ve said before, the root cause of the problems faced by the Swedish banking system was far different from what I think is the root cause of our current financial meltdown, namely, the culture of excessive risk taking engendered by the excesses of American banks executive compensation systems and our peculiar approach to corporate governance in which stockholders have little or no say over how much their “employees” are paid.
Nope. The Swedes, the Finns and the Norweigans all had the same basic problem: they liberalized their banking regulations and had a real estate boom (most intensely in Finland), and then there was a downturn and the banks blew up. Relatively low executive pay did not prevent the banks from blowing up. Just like the CRA did not drive a housing bubble. In both cases it may have intensified things, but the problem is the regulators cut the banks loose and then it was off to the races.
max
['We just dug ourselves a deeper hole.']
February 25th, 2009 at 12:22 am
There is another option–to start new banks with federal money. This can be accomplished by taking over small failing banks in each FRB area and enlarging them to compete with C and BAC. Now, if C goes bust, money can easily be transferred to the new entities. There’s something very unsettling about Uncle Sam owning Citi–let it fail–let it be a lesson to future bankers. Eventually, the feds can privatize the newly created banks to regain money spent.
February 25th, 2009 at 12:55 am
Max and DTM,
My point is that the fundamental problem here is not simply too much leverage or a housing bubble or poor decisions. I agree that both highly paid and reasonably paid executives are capable of exercising poor judgment and making costly mistakes. Here is where I think we differ: I believe that on the whole the Swedish bank executives tried their best to do what was the bank’s long term best interest because their individual interests were more closely aligned to the bank’s and also because it was impossible for them to score life-changing money in a single year or two.
By contrast, in the American system, it’s quite permissible to shaft the company’s shareholders become rich beyond most peoples’ wildest dreams.
American money-center banks like Citigroup and JPM allow their executives, especially the more high ranking, to acquire staggering, truly life changing sums of practically overnight by gambling with other peoples’ money. If you’re the CEO of Citigroup, you start out getting $20-30 million in the first year and, maybe $50 million the next. Plus, it’s important to remember that the pile of OPM available to take as executive compensation is truly vast and the “agency dilemma” guarantees that there is virtually no shareholder oversight. Don’t forget, in most American investment banks and brokerage firms, nearly half of all annual income is paid out in the form of “employee” compensation.
So, somebody like Stan O’Neal or Chuck Prince has the ability to bleed maybe $50-$100 million from his company in a single year. The traders, the guys who put together the deals, they all have the potential to hit the jackpot in any single year—-and we’re talking millions of dollars—far more money than a thousand hard-working, poorly paid but “irrationally exuberant” Swedish bankers would make in a thousand lifetimes.
And the way it’s set up, if the bets they place pay off—they get millions. If they lose, they still get millions. It doesn’t matter because you’re betting with OPM! OPM is free money! Chuck Prince ran the world’s largest, richest bank into a ditch and still got $60 million as a consolation prize. Stan O’Neal did even better for himself. He got nearly $160 million as his going away present.
This isn’t like the Swedish experience where you had basically a one-time event that could be corrected and the banking system would return to normal. Here, there are powerful incentives to bet recklessly even at the risk of the corporation being wiped out. As James Surowiecki said: “The moral-hazard argument also assumes that the most important factor shaping corporate decisions is the interest of the company as a whole. But, more often, what’s shaping those decisions is the interest of individuals, and on Wall Street those interests are often only loosely connected to the long-term health of companies. The fact that people can reap enormous rewards for decisions that are beneficial in the short term but costly in the long term is likely to lead to reckless behavior, regardless of whether companies are bailed out or not. Even if we allow Citigroup to fail, after all, Chuck Prince, the former C.E.O., will still have walked away with a package reportedly worth more than seventy million dollars.”
This was not a bubble. This was not irrational. These people had every incentive to gamble recklessly, even if it meant total disaster for the shareholders because they got paid no matter what. As things stand now, “nationalization” without fundamental reform of the incentives and pay structures isn’t going to help anything except that it will make vast amounts available as “incentives” and “performance bonuses” for CEO’s and their cronies. And, in the end, these guys won’t change because we will have just handed them a bottomless pit of taxpayers’ money to gamble with. The Swedish experience is not analogous because the American bankers will continue to act recklessly because the incentive system in our banks and financial institutions make it too easy to steal really big money.
February 25th, 2009 at 1:04 am
Mal,
In what sense would it be a lesson to future bankers? I can assure you that the rich bankers who caused our current predicament and who many actually have caused another world-wide crash—-a depression which might last many, many years—-have protected themselves and their ill-gotten gains by tucking away their millions in “safe haven” banks. If there is a crash, the bankers will be riding it out in comfort.
I really want to know: How does letting Citibank fail teach Chuck Prince a lesson? How would letting ML fail teach Stan O’Neal—he of the $160 million going away gift—-a lesson?
If there is a collapse, you may be sure that the bankers and others who were responsible will be perfectly safe. They won’t lose a penny of the money they looted from their companies and the government; they won’t have to give any back or change their lifestyle at all. Look at what ML did with the taxpayers money—just looted it and nobody in government is trying to get our money back. ML is wiped out, but the bankers got massive bonuses, billions of dollars, why should they care if ML collapses?
February 25th, 2009 at 2:16 am
Matt,
You are one of the most prominent political bloggers in America, which means you probably have the ability to get important people to take your calls. Why not take advantage of that?
Instead of having an imaginary dialogue with William Isaac, why don’t you call him and have a real dialogue with him? Looks like he’s based in D.C., so maybe you can even get a free lunch out of the old guy. This looks like his office number: 202.466.4422. Why not call him and then post a summary of your conversation with him?
February 25th, 2009 at 8:05 am
we do have an example from the world’s second-largest economy of what happens when you try to go down this road.
Actually, we don’t. The Japan comparison does not work as in Japan the government forced the banks to lend money to failing companies rather than allow them to fail…..very different from the U.S. situation so far.
In addition, only Citigroup really seems to be on the edge. Bank of America can most likely earn it’s way out of the hole with no further capital infusions just give it a little time and even the same can be said for Citigroup.
I understand the desire for nationalization as a populist politics kind of ploy, but it doesn’t really make sense to me as a way to get the banking sector going again. Either you nationalize the vast majority of the 7,400 banks in the United States because you believe the it’s the best way to get credit flowing again, or you you just give the banks some regulatory forbearance and let them heal themselves. Nationalizing a bank or two does nothing to get the credit market going and actually freezes the market as the uncertainty introduced drives private capital to the sidelines.
February 25th, 2009 at 8:07 am
Matt,
Terrible analysis. First off, there are more than 2 things you can do in this crisis. Rewriting mark to market is but one of many suggestions that don’t require massive taxpayer dollars (read inflation) and don’t set us up for failing to properly manage the banks and ALL of their branches around the world. Along those lines you might want to read what Bernake said yesterday.
Lately, your analysis has gotten more political and less rigorous. I’m not going to speculate on why that is given the circumstances, but I would hope that it improves quickly. No one is asking for agreement on means, but let’s not just omit things that are politically unpopular to the left.
February 25th, 2009 at 8:21 am
The FDIC nationalization process works well for dealing with small insolvent banks, so faced with a large insolvent bank we should do something similar.
This also is troubling. On the one hand Matt talks about nationalization, but then he is also advocating liquidation by saying that the FDIC process should be used on large banks…this would in essence wipe out the governments preferred shares investments. I don’t really see any logic in doing that either.
Let me echo what Ed Smythe said about mark-to-market accounting. If you just reworked the rules to be rational it it might pretty much solve all the banking problems and it would not cost a penny.
February 25th, 2009 at 8:23 am
Oh and could we drop this strawman of Japan please? Matt, you basically live in NYC, why don’t you go find some intelligent banker to explain to you the significant differences between Japan circa 1990 and the US of today. For starters Japan’s banks were essentially involved in a Ponzi scheme where each Japanese bank gave sweetheart loans to one another because THEY WERE JAPANESE. When the gravy train ran out, these banks were exposed to the real world where their cutting corners to give each other an edge no longer functioned-hence failure. That was almost universally a local problem…if you haven’t noticed ours is global.
Second, and most important, Japanese banks were almost entirely the single source for credit for their economy. Credit sources in our economy are far more diversified (remember how I keep counseling you guys on our “dynamic economy?”).
In short, do yourself a favor and go to 3rd avenue, or 6th and buy a drink for an intelligent banker…preferably one who’s lived through the 1980s debt crisis. Or better yet, if you’d like, I’m happy to give you the names of some that might just help you to lookbeyond the expert analysis that’s coming from a bunch of 20 something think tank interns.
April 5th, 2009 at 12:37 pm
Is there a way to become a content writer for the site?