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The Wisdom of Not Nationalizing

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Back when everyone was arguing over nationalization, it was pretty common to hear people invoke Sweden's example. Sweden had survived a financial crisis a few years before, and done so by nationalizing the country's major banks. This was pretty central to the case for nationalization. In a memo to Obama, Summers explained why he disagreed.

Furthermore, Summers said, there was a medium-term risk that nationalized banks would lose value, in the same way that the act of foreclosure decreases the value of a home. Summers pointed to the example of Sweden, which was regularly cited by economists who favored nationalization. But Summers noted that Sweden didn’t nationalize for two and a half years, by which time the situation had become so severe — interest rates had reached a hundred percent — that there were no other options. In addition, Nordbanken, the largest bank nationalized in Sweden, was already eighty per cent government-owned. Summers concluded by emphasizing that nationalization was a strategy that governments turn to only after it is very clear that nothing else can work.

The Treasury Department's Gene Sperling puts it neatly a few paragraphs earlier. "You might come out and say, ‘I’m gonna take over Bank of America and Wells Fargo, but everybody else is safe!’ Maybe they believe you. And maybe they don’t. But if you get this wrong, the Dow’s at thirty-five hundred! You’re the worst economic manager in the history of the United States!”

Nationalization is the only major policy issue I've ever written about that I never felt able to take a position on. There was a strong case in favor of the policy, and in particular, a strong case that the best possible outcome was a nationalization that worked beautifully. But supporters, I thought, were a bit too cavalier about the downside risk. This was the foundation of the administration's argument, and it seemed convincing. Particularly after I listened to This American Life report on the technical details involved in the FDIC assuming control of a small bank. Whether nationalization was a good idea in theory, it seemed pretty tricky in practice. And the cost of any serious mistakes seemed virtually incalculable.

Part of the thesis of Lizza's piece is that the Obama administration's refusal to nationalize, which was partially a result of Larry Summers's influence, has proven smart. The belief is widespread across conversations I've had with other administration officials. And some of the more prominent nationalizers -- Felix Salmon, for instance -- have decided that they were wrong and the administration was right. The argument isn't that a perfectly executed nationalization couldn't have left us in a better place. It's just that we're in a relatively acceptable place -- or on a relatively acceptable path towards a relatively acceptable place -- and we got there without risking the downsides of a botched nationalization.

Photo credit: By Linda Davidson -- The Washington Post

By Ezra Klein  |  October 5, 2009; 5:31 PM ET
Categories:  Economic Policy , Solutions  
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Comments

We are left with "Too big to fail." Where will that lead us?

Posted by: glewiss | October 5, 2009 5:46 PM | Report abuse

I guarantee you we're going to be looking at nationalization again in your lifetime, Ezra, so you'll get another chance to see how it might play out.

The main argument for nationalization in my mind was that it would give the government the upper hand to re-regulate the industry.

Not only are we not going to get meaningful regulation, but the U.S. taxpayer is fairly explicitly backstopping the entire multinational financial sector.

Posted by: bmull | October 5, 2009 6:10 PM | Report abuse

Huh? So we have tens of millions of dollars in salaries and bonuses still being paid to irresponsible bankers at the most at-risk, government-backed banking institutions. We still have the most dangerous derivative trading going in the same institutions and dependent institutions (Goldman, etc) on as documented in many recent articles.

Can you explain to me how this outcome is better than taking over the most at-risk big banks, terminating their management and putting their real assets under responsible management?

Posted by: opal22 | October 5, 2009 6:15 PM | Report abuse

This is a complex issue.

There's what's politically possible, and how much political capital it will cost, at least in the short or medium run, especially with health care looming and so worthy of the available political capital.

And then there's what would be best for the country, if politics weren't a consideration. In that case there were strong arguments for temporary nationalizations. I strongly suggest, if you haven't already, that you read Nobel Prize winning economist Paul Krugman's posts and columns on this.

The nationalization route might have cost taxpayers hundreds of billions of dollars less, as so much taxpayer money wouldn't have been subsidizing the finance companies' stockholders, bondholders, and managers.

Sperling said, "if you get this wrong, the Dow’s at thirty-five hundred", but the vast majority of companies in the stock market are not finance companies. Today they make up only about 12% of the value of the Wilshire 5000. And with nationalization, the government could have made sure credit started flowing again freely, and quickly, which was crucial to all of the other stocks, and to the economy. Without nationalization this was less certain. Therefore, the risks to the stock market and the economy might have been greater from not nationalizing than from nationalizing.

There are also long term issues. Bailing out the finance companies and subsidizing them to such a great extent will encourage moral hazard, more of the same in the future. There would be very different future incentives if many of the biggest companies were nationalized leaving the stockholders with complete losses, the bondholders with large losses, and the key managers unemployed, or employed with salaries with less zeros at the end, and contracts that don't encourage bilking tax payers and stockholders, and endangering the economy.

And passing finance reform would be far easier with these companies nationalized, rather than bigger than ever, and spending more millions than ever on lobbying and buying off congress people.

Finally, with regard to, what if the nationalization were done poorly, you just said yourself in a post today that the Obama administration could be trusted to do things right and competently once it had decided to.

There's a lot to consider here, and given Paul Krugman's amazing track record, intelligence, and knowledge, his opinion carries a lot of weight.

Posted by: RichardHSerlin | October 5, 2009 6:17 PM | Report abuse

I think Lizza and others are missing the point because Summers & Co. are trying hard to hide it:

We were *not* talking about nationalizing All Banks.

Just the Zombie ones.

Some of the banks were in good shape, though some like B of A got in worse shape when they ate Dead Companies either by choice (Countrywide, though they were incented to eat that one) or by arm twisting (Merrill Lynch). No one was talking about uncle sam eating those. Wells Fargo was in very good shape relative to the worst.

What people were talking about was eating Citibank and a handful of banks like that.

Summers & Co. want people to think the conversation was about nationalizing the entire banking system. It wasn't, and folks shouldn't delude themselves into thinking that.

John

Posted by: toshiaki | October 5, 2009 6:19 PM | Report abuse

"Whether nationalization was a good idea in theory, it seemed pretty tricky in practice. And the cost of any serious mistakes seemed virtually incalculable."

Right now the US government has $27,000,000,000,000 ($27 trillion) dollars in risk exposure due to our "low risk" approach to saving the banking system - TARP was just pocket change. While not even pessimists expect the US to max out on that, prudence indicates that we may become liable for a substantial fraction.

Worse, the same high risk strategies that got us into this mess are still popular, except using funds guaranteed by the FDIC. Talk about setting up for a calamity. And US banks are far from done purging their toxic assets.

"Part of the thesis of Lizza's piece is that the Obama administration's refusal to nationalize, which was partially a result of Larry Summers's influence, has proven smart. The belief is widespread across conversations I've had with other administration officials."

Would you really expect administration officials to say otherwise?

Posted by: alex50 | October 5, 2009 6:25 PM | Report abuse

We're a long way from the end of the recession, and nowhere near being able to say that it isn't a depression. Check back in 2012 and we'll see how it worked.

sPh

Posted by: sphealey | October 5, 2009 6:31 PM | Report abuse

In my mind the benefits of nationalization were:
#1 Moral Hazard. Bailouts create expectation of future government support. Nationalizations create expectation that the government will wipe you out.*

#2 Regulatory reform. We spent a bunch of money keeping these companies from dying, and now that they're recovering they're using their resources to block very modest regulatory reforms. If the government controlled these companies, they wouldn't be blocking reform.

Note that both of these issues can only be evaluated in the long term, but if five years from now we find that we haven't reformed our financial regulations and companies are back to high-risk bubble behavior. We'll have a strong reason to believe we messed by not nationalizing.

*Note, number one is also one of the strongest arguments against nationalization. A fearful, cautious financial sector would have recovered more slowly.

Posted by: zosima | October 5, 2009 7:22 PM | Report abuse

Agree with Toshiaki @6:19: Summers and Obama have tried hard to equate the need to "nationalize the zombie" banks with nationalizing all American banks. Really disappointing. Totally dishonest rhetoric. It no more true than a claim that the Resolution Trust Corporation took over all savings and loans after the S&L crisis of the Reagan/Bush I administration after 1989. They liquidated the assets of insolvent S&L's and thats what should have happened to Citibank and a few other zombies.

Posted by: opal22 | October 5, 2009 7:35 PM | Report abuse

In my mind the benefits of nationalization were:

#1 Moral Hazard. Bailouts create expectation of future government support. Nationalizations create expectation that the government will wipe you out.*


*Note, number one is also one of the strongest arguments against nationalization. A fearful, cautious financial sector would have recovered more slowly.

Posted by: zosima | October 5, 2009 7:22 PM

===================

WTH?

The Moral Hazzard is that if the Financial Industry drives us off the cliff, Uncle Sam will not only save them, but make them stronger and allow the people who drove us off the cliff not only to retain their jobs, keep getting big bucks and have no incentive to correct their behavior.

If Uncle Sam didn't step in, CitiBank would have gone BK. Investors would have been wiped out. Ask the investors of Wachovia and WaMu how they're doing.

John

Posted by: toshiaki | October 5, 2009 7:59 PM | Report abuse

Some may be tempted to say that Summers opposed because of political difficulties whereas Krugman does or did not give that much attention to 'politics' of the issue when he kept on insisting nationalization. I doubt that. In other words to bring Summer's argument against nationalization in economic terms to 'zero' is not right. In hindsight, he opposed nationalization both on economic and political basis.

Question is this is one hell of a call missed on Krugman's part. We have not heard any mea culpa about that from him. He needs to do that.

As he admitted, Ezra was ambivalent.

For my part I was more interested Fed 'popping up' / backing up regional and non-Wall Street banks so as to leave culpable big banks for survival on their own. For major part of my life since I lived in India where most of the banks were nationalized for decades and had seen how that was detrimental to the growth; I could not have been pro-nationalization. For that matter any minimally thinking Indian person would be against nationalized banks considering how stagnant everything was then.

The next test for Obama Economic Team is about finance industry regulations. No promising start so far. However, with their accomplishments thus far, no one can write them off. But to think they will be able to address these reforms in fundamental way considering all sorts of early signs where they seem to be beholden to 'big boys of Wall Street'; is a leap of faith for now.

Will be glad to be proven wrong here.

Posted by: umesh409 | October 5, 2009 10:59 PM | Report abuse

Sometimes, Ezra, you seem to have critical sense and sometimes you seem to shut off your critical senses. It is as though you evaluate certain ideas based on how they make you feel and other ideas according to how they accord with some external reality, data, etc.

In this post you seem to feel the need to be "agreeable" with the Administration when we have a lot of data suggesting that this is a superficial analysis of the situation. Yes, Salmon seems to have been "peeled off" by this account but this unfortunately does not change the analysis of many, including Dean Baker, that we are facing a greater exposure to risk and "too big to fail" remains a major issue.

I'm wishing you would use your analytic abilities more consistently to arrive at a consistent position rather than "titrate" your criticism according to how it positions you in relationship to the Administration. Maybe I am too critical of the Administration but you seem to dart in and out in a way that indicates you are interested in representing a "flavor" rather than a set of convictions about journalism, economics and the world.

Posted by: michaelterra | October 6, 2009 3:55 AM | Report abuse

Ezra,

Please think about this: There are a lot of ways temporary nationalizations could have been done.

First, we did not have to nationalize many banks, to get credit flowing very quickly and avoid hundreds of billions of taxpayer dollars flowing to shareholders, bondholders, and managers. As Paul Krugman noted:

The four biggest US commercial banks – JPMorgan Chase, Citigroup, Bank of America and Wells Fargo – possess 64 per cent of the assets of US commercial banks (see chart) [chart not available online]. If creditors of these businesses cannot suffer significant losses, this is not much of a market economy.

at: http://krugman.blogs.nytimes.com/2009/03/04/how-many-banks/

Second, the nationalizations did not have to be as intense and resource requiring as the small bank example you linked to from "The American Life". These could have been more like a quick Warren Buffet (temporary) acquisition of four or five large banks. These kinds of acquisitions and takeovers happen all the time without immediate catastrophic disruption. A few of the top management would be replaced, but the rest of the bank and its employees would be kept in place. The difference would be that with the government temporarily in control, in full ownership, they could inject huge amounts of capital without having it just flow right back out to the bondholders, shareholders, and managers, and they could have ordered the banks to start loaning heavily immediately. This easily might have decreased the risk to the stock market and the economy, and decreased the severity and length of the recession.

Posted by: RichardHSerlin | October 6, 2009 7:14 PM | Report abuse

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