Nationalizing the Banks Seems Inevitable: How Bad Does It Have to Get First?

There is a bottom-line to the banking crisis which the Obama administration appears intent on trying to avoid: some number of financial giants are simply insolvent. A recent analysis by NYU economist Nouriel Roubini -- known as "Doctor Doom" for his dire predictions about the collapse of the financial trading system, predictions that have since become painfully true -- estimated that the losses facing the American financial sector will reach $3.6 trillion dollars.

In the past, governments, including that of the first Bush administration during the savings and loans failures of the late 1980s, have taken over insolvent institutions that were judged to be "too big to fail." They fired most of the management teams, wiped out the banks' shareholders, protected depositors, and sold off the institutions assets in an orderly way, minimizing the shock to the larger economy.

Following the floundering, piece-meal interventions presided over by former Treasury Secretary Hank Paulson, the chorus calling for nationalization has grown. Once considered a radical move, even fiscal conservatives like Senator Lindsey Graham (R-SC), have suggested that this might be the least-expensive route to saving a financial system on the brink of collapse. On ABC's This Week, Graham said, "This idea of nationalizing banks is not comfortable. But I think we've got so many toxic assets spread throughout the banking and financial community, throughout the world, that we're going to have to do something that no one ever envisioned a year ago." "I would not take off [the table]  the idea of nationalizing the banks," he concluded.

But so far, the Obama administration has done exactly that, and while the president has said that his team is loathe to nationalize falling financial giants because of the complexities involved, a closer look suggests that his team is avoiding the move on ideological grounds rather than practical considerations. The New York Times reports, "President Obama's top aides have steered clear of the word entirely," and the Washington Post notes, "Administration officials are … trying to offer federal assistance to financial firms without nationalizing them outright, according to a source who has been in contact with senior Treasury officials." Obama's Treasury Secretary, Tim Geithner, told reporters, "We have a financial system that is run by private shareholders, managed by private institutions, and we'd like to do our best to preserve that system."

But they may not end up having a choice. Contrary to Graham's assertion, many of the "toxic assets" we're hearing so much about these days are concentrated in a handful of institutions, and the first step of the plan outlined last week -- with sparse details -- by Geithner is to dig into these institutions' books and see exactly how healthy or unhealthy they really are. Some see that as a first step to nationalization, even if it were to go by another name -- "restructuring" or "receivership."

But the painful but unavoidable reality of the financial crisis is that every dollar spent trying to prop up a failing bank is just good money thrown after bad; a taxpayer rip-off, short and sweet. Geithner is proposing a vague "public-private partnership" that will somehow raise enough capital to ease the crunch. Roubini argues that "the plan won't solve our financial woes, because it assumes that the system is solvent." Economist Paul Krugman wrote that the political establishment has "become devotees of a new kind of voodoo [economics]: the belief that by performing elaborate financial rituals we can keep dead banks walking." Goldman Sachs' economists estimate that those rituals might cost up to $4 trillion to perform.