Tag Archives: nationalization

Nationalization: Cutting Losses and Creating Solutions

A debate rages on different plains about rescue of the banking industry and real estate market.  That is a clean way of putting it.  Not the debate–the debate is pretty clean.  But the notion that it is just the banks and homeowners who are at risk is pretty sanitary. 

Without banks there is no substantial financing of business activity.  We could reinvent financing, especially since the Internet was not around when the current banking system was begun, but it would take years to reach anything like national capacity.  In the meantime, now, falling business activity continues a downward spiral of unemployment, business failures, investment losses, and postponed planning and recovery.

With no finance and no confidence, there can be no real estate market.  There is only deterioration in values and losses in investment.  Forward business activity and healthy market forces require confidence in the future. 

Hence, the nationalization debate.

If the government takes over weak segments of the banking system, it can, at a cost, make them stable institutions of the recovery economy.  They can loan money without fear of failing for lack of sufficient loan reserves.  Similarly, the government could buy up and hold real property at discounted prices throughout the United States.  This would eliminate the concern that numerous properties sit in default with no payments made on the mortgages and with no interested buyers.  The government is used to owning land in America–it owns much of what is not developed or used.  Add to that a fraction of the housing stock, to be resold later, and you have a more stable marketplace for the remaining property.  (You would have to create a formula such as automatic purchase of all homes in foreclosure at a set percentage discount for a six month period).

Why not nationalize one or both fractions of the marketplace?  Certainly this is not an efficient method of setting prices and running financial and real estate markets.  It would be a really bad idea if you had a functioning marketplace because like the communist economies, it would lead to poor allocation of resources, lack of private incentive and declining productivity.  But, should we be holding out for efficiency, when the very functioning of the system is so broken down?

It must be particularly hard for the Obama administration to look towards nationalization as an option.  The first African American president is hardly a financial liberal or political radical.  He taught at the University of Chicago, a free-market powerhouse.  He was not, so far as I know, part of the “Chicago School” of conservative economics, but neither was he ever noted as a liberal economic standout.  His centrist, free market, choices for Treasury department and economic advisors confirm this.  

What’s the solution?  How about giving a group of responsible Republicans the challenge of crafting and selling the temporary-nationalization plan?  Cherry-pick them in advance so they are willing, at least, to do what is needed.  Despite all our anti-politician rhetoric, there are many among them who are in an of themselves, profiles in courage. 

Rather than indulging in battle over whose party it is, and what it stands for, why not take on the problems of the day and solve some?  

We are clearly at a point of great uncertainty.  The recovery may come as the bottom of the market is reached according to market forces or it may not.  The stimulus spending and tax cuts may aid the recovery or they may not.  But the hole in the plan needs to be repaired, one way or another.

There is a significant, whether that’s one percent or more, risk of more devastation to business activity and investment value.  At some point, rather than aiming for a refined solution, you need to aim to protect yourself from the risk of catastrophe.  Protection from disaster is different than planning for optimal results.  We should, at least someone should, be advancing ideas on that level.

When the countries of the former Soviet Union endured its collapse and economic crisis in the 1990s, industrial production, standards of living, and life expectancy declined deeply.  Painful as it was, within a few years, conditions improved.  We might learn from these experiences as well as from other nations that have had to nationalize collapsing industries, and our own savings and loan crisis in the 1980s.  In each of these cases privatization was eventually successful, so we should not worry about a slippery slope towards socialism or the communist domino effect.  The real risk in those directions comes only if the United States is unable to pull itself up by its bootstraps and demonstrate a viable system.

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Temporary Bank Nationalization

 


Money

Image by http://www.flickr.com/photos/gi/388322867/; license under creative commons

 

I believe it is likely that President Barack Obama and his Treasury Secretary, Tim Geithner, will move to nationalize one or more major banking institutions in the coming weeks. 

This would be a controversial step for the new administration.  And a courageous one. 

The very idea of nationalization is so antithetical to free market economic principles, that this article is bound to illicit alarm and condemnation.  And rightfully so.  Nationalization, especially on this scale, must truly be a last resort.

The two most likely targets are Citibank and Bank of America, with an estimated combined worth of more than $100 billion.  Two banks that are “Too big to fail.”

These banks are also very likely insolvent.  

The Bush administration tried to solve immediate financial problems by investing through the Treasury’s previous $700 billion bailout fund.  Bank of America and Citibank (Citigroup), in addition to receiving their portion of the bailout, also required many additional commitments to insure against losses.  

Lately, the press has focused on scandals over executive pay, lack of accountability for public funds and concern that banks were not doing their part to extend credit. These may be valid, but they obscure the concern that the investment, to date, does not appear to be enough to keep the banks operating.  

So the government has a choice.  

Continue to invest more taxpayer funds, in hopes the tide will soon turn, or face the music and take over the failed entities.  It would be one thing if we were near the end of this recession and the funds were just a bridge to an inevitable recovery, but we’re not. 

Unfortunately, predictions for 2009 are bleak, and as finances go, so does the viability of banks.  A significant rise in unemployment risks another round of foreclosures and a further weakening of bank mortgage portfolios.  

In this light, nationalization is courageous.  With banks insolvent, doing anything else simply puts off the reckoning for a later date.  

Nationalization does not eliminate financial risk, but does give the government the sole right to collect from the sale of bank assets when they are returned to private hands.  

Under this scenario however, current shareholders would most likely see their interests wiped out.

The Obama administration’s plan to support the real estate market is still unknown.  A dramatic act could conceivably stop the mortgage weakness that continues to weigh down the banks, making the path forward more positive. 

However, for the new administration, there is great political risk.  Already facing criticism for preparing to spend nearly a trillion dollars on fiscal stimulus, some of which looks like pork-barrel politics as it goes through Congress, the administration would face a whole new magnitude of concern for its attempt to run the megabanks.
 

There is no doubt that the administration would only be seeking temporary nationalization.  The new team has professed no desire to control or profit from the business of banking, but does have a few good options.  The banks are involved in so many credit, retail and financing operations that a shut down would be disastrous for an innumerable number of its customers still fighting for survival.  

On the other hand, when the bank is returned to private hands, the government, not the current shareholders, would likely recoup much of its investment.

Let’s unlock politics, where do you stand on nationalization of insolvent banks?