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

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

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. 

How would it work? The government would put teetering institutions deemed too big to fail under trusteeship. Many among the current management teams would join the ranks of the unemployed, shareholders would get wiped out -- an important piece of tough love that might dissuade people from following the herd into the next speculation-fueled bubble.

And then the government would liquidate the institutions' assets in an orderly, gradual way. Then, finally, it would sell back smaller, leaner institutions -- without the burden of piles of bad paper on their books -- to the private sector at a later date. 

Perhaps the best rationale for nationalization is that the bursting bubble that precipitated this crisis wasn't in tech stocks or commodities -- it was a bubble built largely on people's homes. The New York Times, which continues to ignore the underlying collapse of the housing bubble, notes that one of the flaws in the plan is that "if the government is perceived as running the banks, the administration would come under enormous political pressure to halt foreclosures." 

But what they call a bug is obviously a feature of nationalization. The foreclosure crisis is spreading, and foreclosed properties fuel a vicious cycle, dragging down real estate prices in the areas where they're concentrated, which in turn puts more homeowners "under water" -- owing more on the mortgage than their houses are worth -- which in turn increases the number of foreclosures.

If the banks were nationalized, the government could declare a moratorium on foreclosures for the properties it controls, and move to restructure mortgages -- perhaps at subsidized rates -- for homeowners on the bubble. 

This is an important part of the puzzle. So far, government efforts to bailout homeowners have had little success, in large part because privately held institutions have an obligation to their shareholders to avoid writing down the principle of loans made on assets whose values have tanked.

So far, all of the government's attempts to bailout homeowners have been structured as voluntary programs, and the terms that the banks require before deciding to bite have been too costly for most distressed homeowners to afford. 

It appears that the idea of nationalization is gaining steam in policy circles, including now in conservative ones. Obama promised a pragmatic approach to the crises facing the country. Nationalizing big, failing banks may smack of statism, but the consequences of tinkering around the edges of the crisis are simply too dire; we've got to leave all options on the table.

See more stories tagged with: financial crisis, nationalization

Joshua Holland is an editor and senior writer at AlterNet.

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