Stop Rearranging Deck Chairs on the Titanic and Nationalize the Damn Banks

By Joshua Holland, AlterNet. Posted January 30, 2009.

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.  

But in Washington, many are trying to avoid that fact nonetheless. 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.

It's time that the government stops flailing around with piecemeal bailouts and loan guarantees, takes over these institutions -- takes them out of private ownership -- sells off their good assets in an orderly way, trashes the toxic stuff and then resells them to the private sector down the road as leaner institutions that are dedicated to the primary purpose of banking: making loans and holding deposits.  

In economic circles, that's the "N-word" -- it isn't a racial epithet, it's "nationalization," and it was unheard of in mainstream discourse just a few short months ago. But it's remarkable how a crisis as deep as the one we face today can change which ideas are considered mainstream.  

In a way, nationalization is the approach that most closely adheres to "free market" principles, which dictate that poorly managed firms should go under, freeing up their human and other capital to be absorbed by well-managed businesses. 

Sometimes, the market works. Wall Street's titans lobbied like hell to get regulators off their backs, they figured out elaborate ways to "launder the risk" out of high-risk debt, and then they engaged in a furious push to get lenders to make more and ever-shakier loans -- the raw materials of those "innovative investment vehicles" that are now known as "toxic securities."  

They did that based on an entirely irrational idea that the housing market would continue to grow dramatically forever, and they did it while ignoring voices of sanity which warned that they were steering those fancy "investment vehicles" right off a cliff. Now, many are teetering on the brink of collapse, and classical economic theory says they should crash and burn. 

But with financial giants like Citi or AIG, the common argument against that course is that regardless of their complicity in creating the global economic meltdown, they're simply "too big to fail" because their collapse would have a ripple effect through the economy.

This is probably accurate; a sudden crash of an institution with hundreds of billions of dollars -- or even trillions -- on its balance sheets would have far-reaching effects. When Lehman Brothers went belly-up last fall, it came close to bringing down the entire global financial system with it. 

But a major problem with all of the approaches tried so far -- and those being discussed in connection with the future of the dubious Troubled Assets Relief Program -- is they're all premised on the idea that these faltering institutions can, and should be propped up and remain in the private sector. Their investors' stakes, while worth a fraction of what they were a year ago, are being protected (and many ailing institutions are still paying out dividends).

And while Capitol Hill has been flush with largely symbolic gestures to cap executive pay or limit the shininess of management's golden parachutes, most of the people who ran these institutions into the ground -- as well as the global economy as a whole -- are holding onto their cushy jobs. 

Nationalization is a radical move, but there are real and practical problems with trying to prop up falling banks that are fundamentally unsound. So far, several broad approaches have been bandied about in D.C. All have similar flaws, and all represent an elaborate dance around the N-word. 

The first is to buy up the banks' toxic assets -- the original concept behind the TARP. The government would fund the creation of a "bad bank" to hold onto those assets in the hope that they would increase in value down the road and maybe return some cash to the taxpayers. The argument is that the government can buy and hold that junk with money the private sector can't raise, and also pays less for the cash in the first place.

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Joshua Holland is an AlterNet staff writer.

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