Banks: Time for Permanent Nationalization?

By Fred Moseley, Dollars and Sense. Posted March 3, 2009.

Freed from the need to maximize short-term profit, nationalized banks would also make the economy more stable in the future. They would take fewer risks during an expansion, to avoid debt-induced bubbles, which inevitably burst and cause so much hardship. For example, there would be fewer housing bubbles; instead, the deposits of these megabanks would be invested in decent affordable housing available to all. With housing more affordable, mortgages would be more affordable and less risky.

The newly nationalized banks could also increase their lending to credit-worthy businesses and households, and thereby help stabilize the economy and lessen the severity of the current recession. As things stand, banks do not want to increase their lending, since the crediworthiness of any borrower is difficult to determine, especially that of other banks that may also hold toxic assets. They have suffered enormous losses over the last year, and they fear that more enormous losses are still to come. Banks prefer instead to hoard capital as a cushion against these expected future losses.

What the government is doing now is giving money to banks in one way or another, and then begging them to please lend this money to businesses and households. Nationalization is clearly the better solution. Instead of giving money to the banks and begging them to lend, the government should nationalize the banks in trouble and lend directly to credit-worthy businesses and households.

How would the nationalization of banks work? I suggest the following general principles and guidelines:

• The federal government would become the owner of any "systemically significant" bank that asks for a government rescue or goes into bankruptcy proceedings. The value of existing stock would be wiped out, as it would be in a normal bankruptcy.


• The government would itself operate the banks. Top management would be replaced by government banking officials, and the managers would not receive "golden parachutes" of any kind.


• Most importantly, the banks' long-term bonds would be converted into common stock in the banks. This would restore the banks to solvency, so they could start lending again. The private common stock would be subordinate to the government preferred stock in the capital structure, which would mean that any future losses would be taken out of the private stock before the government stock. Bondholders could also be given the option of converting their stocks back to bonds at a later date, with a significant write-down or discount, determined by bankruptcy judges.

These "bonds-to-stocks" swaps (often called "debt-to-equity" swaps), or partial write-downs if the bondholders so choose, are a crucial aspect of an equitable nationalization of banks. The bondholders lent their money and signed contracts that stipulated that if the banks went bankrupt, they might suffer losses. Now the banks are bankrupt and the bondholders should take the losses.

This process of accelerated bankruptcy and nationalization should be applied in the future to any banks that are in danger of bankruptcy and are deemed to be "systemically significant." This would include the next crises at Citigroup and Bank of America. Other banks in danger of bankruptcy that are not "systemically significant" should be allowed to fail. There should be no more bailouts of the bondholders at the expense of taxpayers. In addition, the banks who received some of the first $350 billion should be subject to stricter conditions along the lines that Congress attached to the second $350 billion -- that banks should be required to increase their lending to businesses and consumers, to fully account for how they have spent the government capital, and to follow strict limitations on executive compensation. The government should withdraw its capital from any banks that fail to meet these standards.

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Fred Moseley is a professor of economics at Mt. Holyoke College.

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