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

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

But there's a big problem with the idea of creating a "bad bank." Asset prices are so low right now that either the government overpays for them, providing a huge subsidy to shareholders in companies that are on the shakiest of ground, or it pays a fair value for those assets, in which case banks holding large amounts of debt-based securities would have little incentive to participate. If they did, they'd go belly-up anyway (if they could simply sell off their crappy paper at current prices -- however one determines what those prices are in a market that's essentially shut down -- we wouldn't be in this mess).

Another proposal -- one that has gained currency since the first round of TARP money was dished out -- is to "recapitalize the banks" by buying stock in the firms. The government would basically become an investor, and assuming that the institutions in question rebounded, it could later sell its shares and recoup some or all of the dollars taxpayers threw at them. 

Here, there's a similar problem. The value of bank stocks are at rock bottom, and there's a reason for that: they represent a terrible investment, and that would effectively make the U.S. taxpayer the sucker of last resort -- a chump who would buy into a failing institution.

Yes, it's possible that somewhere down the road, these banks would return to health, but it's important to recall that the financial sector has become bloated with excess capacity, so that outcome is anything but guaranteed, and at the very least would take years to realize. 

The U.S. government has already taken this approach, "partially nationalizing" several banks. But when the feds only go partway, we get ripped off. In the case of Bank of America and Citigroup, the Fed pumped more money into those banks than their entire market value, and in exchange taxpayers got a 6 percent stake in BofA and 7.8 percent of Citi. As econ-blogger Barry Ritholtz noted: "How 120 [percent] of a company's market [value] yields a single-digit ownership stake is beyond my comprehension." 

Perhaps the biggest problem with this approach is that while the public gets a stake in the banks' future, so far it's given the government little or no say over how the banks do business while they enjoy the public's largesse. Banks are reportedly hoarding money to beef up their balance sheets, using TARP funds to pay out dividends and bonuses, or buying up smaller, sicker institutions.

There's plenty of talk in Congress about requiring greater transparency of firms receiving TARP funds -- along with talk of requiring them to lend money (stupid talk; making banks lend to maxed-out individuals and cash-strapped businesses that aren't creditworthy is the epitome of doing the same thing over and over and expecting a different result), of caps on CEO pay and all the rest -- but it is virtually impossible to fully account for those funds when they're ultimately being doled out by corporate managers. "Leakage" is inevitable; there's really no way to guarantee that a TARP dollar doesn't end up being spent on purposes other than for those which it was intended. 

Another tool in the kit is to guarantee the value of the banks' holdings -- essentially making the government an insurance broker (this was part of the bailouts for Citi and BofA, and has been done aggressively in the U.K.). But this may be the worst solution, for much the same reason: as the underlying assets tank -- and most analysts say we're not near the bottom in real estate -- the cost to taxpayers will be enormous, and they'll get nothing in return.

The premiums required to make that insurance business profitable (or a break-even) for Joe and Jane TaxPayer would be exorbitant, so banks taking advantage of the program would give the government equity in return -- again, that's partial nationalization.

Nationalizing the banks outright is another story.  "The case for full nationalization is far stronger now than it was a few months ago," Adam Posen, the deputy director of the Peterson Institute for International Economics, told the New York Times. "If you don't own the majority, you don't get to fire the management, to wipe out the shareholders, to declare that you are just going to take the losses and start over. It's the mistake the Japanese made in the '90s."

Nationalizing failing banks outright would be expensive, and comes with risk, but it's a way to address most of the crucial flaws in the ad hoc approach taken so far. 

See more stories tagged with: financial crisis

Joshua Holland is an AlterNet staff writer.

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