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February 10, 2009


"Too big to fail" is too big. Nationalization gives us a good way of breaking up the far- too- large banks into more manageable hunks.

Now, how to keep them from rebuilding (see the phone companies) or all making the same bad assumptions at once (current mess) is an Unsolved Problem.

Well said hilzoy. Part of your unending mission to make me feel inadequate through comparison ;)

Eric: I thought it was the other way around -- there's a reason I don't write as much as I used to about Iraq, and it isn't lack of interest. ;)

This is the main reason why I tend to favor nationalizing those banks that are insolvent, clearing up their balance sheets, recapitalizing them as needed, and sending them back into the private markets as soon as is prudent.

But is it easy to tell which banks are insolvent? Citi and AIG are toast, but BoA claims to not need more bailout cash. Is that true? What about all the banks that received TARP money but not "extraordinary assistance"? Nationalizing all of them would require an enormous surge of government resources and expertise - but letting them go on without aid would doom a lot of them to become insolvent where a not-huge injection of capital might keep them alive. It seems to me that nationalization is a very blunt instrument that faces a lot of allocation uncertainty issues - just like TARP I and II.

He resisted those who wanted to dictate how banks would spend their rescue money. And he prevailed over top administration aides who wanted to replace bank executives and wipe out shareholders at institutions receiving aid

This is utter crap.

White House comment line: 202-456-1111.

h/t atrios.

By all means, call them up. Who knows, maybe it will make a difference.

Pace Yves and others, I knew I was going to hate this plan once it came out. Looks like I'm not going to be surprised here.

Nationalization would, in short, accomplish what my market principles tell me we should do: specify exactly what the bad consequence is that we want to avoid, and craft a policy solution that avoids this particular bad thing while either leaving other market signals intact or (where this is impossible) mimicking them.

Best not to be coy here. The bad thing we have to avoid is a general systemic failure via cascading defaults of all the major participants in the banking system, in which swaps contracts (e.g. Credit Default Swaps) would play a large role, because the players are very tightly coupled to each other. That was what scared everybody so badly when Lehman failed - it became appalling obvious that the counterparties are so tightly tied to one another that you can't kill off one of them without killing them all.

The main advantage of putting the banks through what is effectively a bankruptcy and liquidation process (without actually calling it that) under the guise of nationalization is to avoid triggering a swaps cascade by pretending that the firm in question has not actually failed. The problem I see with this is I don't think you can actually get much in the way of liquidation (or "restructuring") done while still maintaining plausible deniability regarding the failure of the firm in question. At some point not very far down that road we will be forced to either freeze the zombie banks as they are, or to face the swaps contract monster.

I wonder if it would be simpler to declare the CDS en-toto as null and void, on the grounds of that they were effectively insurance contracts which were not submitted via the appropriate regulatory framework.

Would that be enough to decouple the fate of individual firms so the bad ones can then be allowed to fail without taking their counterparties down with them, and if this is desireable from a policy standpoint, can a legal framework be constructed to nullify the CDS market on a non-arbitrary basis?

I don't know the answers to those questions, but I think any solution to this problem which makes no attempt to untie the web of counterparty relationships binding all of the major banks to each other is doomed to end up at the same zombie-bank 1990s Japan style destination.

The main advantage of putting the banks through what is effectively a bankruptcy and liquidation process (without actually calling it that) under the guise of nationalization is to avoid triggering a swaps cascade by pretending that the firm in question has not actually failed.

Wouldn't it just be cheaper to keep the population stoned for the next 5 years?

TJ: Sign me up.

I think that the market is a very good way of transmitting price signals, and that while government can and should regulate it in various ways, its advantages should not be set aside without some good reason.

Agreed. This is more or less what I've meant in past comments when stating that I consider government to be a "necessary evil", and that it should be "as large as necessary and no larger."

people who like markets are on the right and the more they like markets, the farther to the right they are. And people who like nationalization are on the left, and the more they like nationalization, the farther to the left they are.

Well, I hate those stereotypes. People around here assume that I'm a Norquistian Republican because most of the time when I comment it's to ridicule your economically illterate, zero-accountability, big-government fetishist colleague, Publius; personally, I'd consider myself a socially liberal small-government libertarian. Nevertheless, I think your reasoning in this post is excellent, and I think you've laid out a good argument for nationalization.

I'm a big fan of competitive markets, because robust competition enforces accountability and spurs innovation, while monopolies, public or private, inevitably degrade. But perpetual competition is an unnatural state -- in nature, winners dominate and crush their rivals. It is sometimes necessary for a reluctant government referee to intervene to maintain a functioning marketplace. This is one of those times.



Publius and Hilzoy are acutally different people with different ideas. Which makes your strident attack look a little silly...

Czarism in Action ...Sirota

How can this be a $1.5 trillion plan, that doesn't ask Congress for any more money? Because the Treasury Secretary is effectively circumventing the legislative branch - ie. popular democratic channels - and relying on autocratic means of handing over more cash to Wall Street, most prominently, the Federal Reserve

"...the Treasury Secretary is circumventing..." ???

I always understood that the responsibility the last administrations crimes was assigned to Rumsfeld and Cheey so that when a Democratic neoliberal ascended to the throne those same voices could claim that the Czar(!) couldn't possibly know or understand what the Cossacks were doing.

I think Creamy means Hilzoy's colleague, whose name is "Publius." I don't believe Creamy was directly addressing Publius.

Ahh, I see, I got distracted by the linky underscorededness. :)

The idea that the banks are free market adherents defies belief. We have a Crony Welfare State. They were betting on and expecting government guarantees purchased through lobbying. Geithner is talking gibberish. The plan perpetuates our Crony Welfare State arrangement. Are we spending any less than Britain or Sweden did? Please.

In case you haven't seen this yet (IIRC Yves may have a link up) it is worth a read: Ray Dalio thinks we need to nationalize the banks, but that is only a start. A broad restructuring (i.e. selective defaults and writedowns) of debt is needed. Some of this interview is just standard talking-his-book, but the key bits (IMHO) are this:

However, the reason it hasn't actually produced increased credit activity is because the debtors are still too indebted and not able to properly service the debt. Only when those debts are actually written down will we get to the point where we will have credit growth. There is a mortgage debt piece that will need to be restructured. There is a giant financial-sector piece -- banks and investment banks and whatever is left of the financial sector -- that will need to be restructured. There is a corporate piece that will need to be restructured, and then there is a commercial-real-estate piece that will need to be restructured.

Is a restructuring of the banks a starting point?

If you think that restructuring the banks is going to get lending going again and you don't restructure the other pieces -- the mortgage piece, the corporate piece, the real-estate piece -- you are wrong, because they need financially sound entities to lend to, and that won't happen until there are restructurings.


But the future of banking is going to be very, very different. The regulators have to decide how banks will operate. That means they will have to nationalize some in some form, but they are going to also have to decide who they protect: the bondholders or the depositors?

Nationalization is the most likely outcome?

There will be substantial nationalization of banks. It is going on now and it will continue. But the same question will be asked even after nationalization: What will happen to the pile of bad stuff?

Hilzoy, well put, a very good summation of the problem with our reverse-Stalinist free-market ideology.

Your analogy here is instructive:

I imagine that if enough kids die of tainted milk, a decent market will in fact produce some way in which consumers can buy milk that is not at risk of being tainted, but since that will happen only after a number of kids die, we should opt for food safety inspections instead.

Don't be too sure. Exactly that problem arose in the 19th Century, and the 'market' solution was to bypass the market and give the problem to the entity much better able to handle it, government. Our growing cities needed and got a better food distribution system, which was ripe for abuse by farmers and middlemen. Claims of adulterated milk were common enough to prompt Thoreau's famous quip, "Some circumstantial evidence is very strong, as when you find a trout in the milk." Once pasteurization and refrigeration were invented, doctors strongly recommended milk for children -- yet consumers could not count on the milk getting to their doorstep without being diluted and tainted. This children's health issue was one of the big spurs for the creation of the FDA and other regulatory bodies.

Could a market solution have been found? There were early private quality assurance bodies (Good Housekeeping, heksherers, etc.). But they could not as reliably monitor compliance or prevent abuse of their mark. Consumers could not count on private rating entities to do their job well or honestly -- a problem that played a significant role in our current financial crisis as well.

Of course, a government regulator can be incompetent, misled, or bribed as well. Some argue now that government pasteurization mandates destroy nutrients and make milk less healthy -- but having this argument in public is a big step up from trying to choose among competing private rating agencies.

What will happen to the pile of bad stuff?

What are the possible things that *could* happen to the pile of bad stuff?

In other words, what options are there?

A certain hysterically anti-socialist perspective was opposed to the U.S. government acting like a competent and interested customer / investor in negotiating for pharmaceutical prices for Medicare.

A related anti-socialist perspective now holds that the government should in no way act like a competent and interested customer / investor in bailing out failed banks with crashed assets and huge debts based on imaginary financial instruments.

There is a pattern here.

Seems pretty sensible, but then, I am pretty hungover this morning. One comment got me, " It would allow us to replace the senior management at the banks, which would give them every incentive to avoid needing to be nationalized." Where do we go for the replacement senior management, particularly with salary caps in place (sure, I'll take a 2mm a year pay cut to try to fix a completely broken bank, no problem)? Will this turn out to be kind of like disbanding the Iraqi army? And finally, I am not getting the connection between firing senior management and incentivizing [who?] to want to avoid nationalization. Of course, maybe if I'd been a better person last night, this would all make sense. Can't rule that out.

Ironically, I think it's the bailout strategy, rather than a nationalization alternative, which so far has proved just how badly government can manage its money economically. After all, the U.S. government has now invested into Citigroup and Bank of America, for example, several times those firms' value on the stock market. And for its investment, it has received no control over those corporations.

If that's not bad business sense, I don't know what is!

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