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

By Joshua Holland, AlterNet. Posted February 16, 2009.

The Geithner plan is not fully fleshed out.  Roubini notes that "establishing an investment fund with private and public money to purchase bad assets," is the cornerstone of the plan.

But unfortunately, the plan won't solve our financial woes, because it assumes that the system is solvent. If implemented fairly for current taxpayers (i.e., no more freebies in the form of underpriced equity, preferred shares, loan guarantees or insurance on assets), it will just confirm how bad things really are.

Nationalization is the only option that would permit us to solve the problem of toxic assets in an orderly fashion and finally allow lending to resume. Of course, the economy would still stink, but the death spiral we are in would end.

However it is structured, the alternative is to keep injecting tax-payers' money into zombie banks, institutions that can't stay in business with their own cash supply. At stake is the length and depth of the recession; failure to act decisively has the potential to mire us in a protracted slump, much like Japan's "lost decade" in the 1990s.

It's time that Congress and the Obama administration stop 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 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."  

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 when the feds only go partway, we get ripped off. Either we end up buying up those toxic assets at today's prices, killing the banks (if they could sell them without going belly-up, they would), or we pay inflated prices and give a massive subsidy to those who got us into this mess.

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." 

And while we've showered the banks with taxpayer largesse, the public hasn't gotten a stake in the banks' future.  Banks are reportedly hoarding money to beef up their balance sheets, using governmnet funds to pay out dividends and bonuses, or buying up smaller, sicker institutions.

See more stories tagged with: financial crisis, nationalization

Joshua Holland is an editor and senior writer at AlterNet.

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