Tackling Nationalization of Banks

Thomas Hoenig, President of the KC Federal Reserve, quotes economist Allan Meltzer: "Capitalism without failure is like religion without sin." His 15-page paper on whether to nationalize is very well written and provides a decent overview of the history of how the US has dealt with these issues post-1929.  Paul Krugman and Alan Blinder offer a few other educated points of view on this issue, but Hoenig seems the best overview. Actually, I take that back; Blinder's comments don't seem well thought through, and many others agree with me, but there's a guy that disagrees with Hoenig and Krugman.

I am told that Citigroup and Bank of America are on the verge of failure. I am not competent to say much more than the fact that I wouldn't think of investing in those companies right now. However, if a company is on the verge of collapse, and the collapse of that company would have catastrophic financial implications for the country/world, then this is a situation in which we need government support to prevent chaos and social collapse.

On the other hand, if a company has made significant mistakes in its management, to the point of collapse, then, normally, the company will shut its doors and/or file some version of bankruptcy. Generally, these companies have not been well run and risk management has been atrocious. The shareholders, board of directors and executives have all failed at their responsibilities: the executives did not manage the company well, the board of directors did not sufficiently supervise the executives' management, and the shareholders should have read their annual reports, etc., better or asked more questions. None of these people have shown any competence, as clearly demonstrated by their company's failure.

If the failure of the company must be prevented, the only option is government takeover. Shareholders cannot really complain, because their company is already worthless - the other option is bankruptcy and liquidation of assets. (Does anyone really think that AIG, BoA or Citi will be viable in a couple years?) These companies are on death's door. Their only value is to people outside the company.

The last thing we can afford to do is dump money into companies under the same management. We absolutely do not continue to let people have share value or executive salaries in these circumstances. Take over the company. Salvage what can be salvaged. When you have the thing back in a functional form of any kind (and there's a market for this) sell it to someone who wants it.

Another question that we immediately run into, though: What to do with the bank's liabilities? Certainly, there is a strong case for cutting the shareholders loose; I don't really much struggle with that issue from an ethical point of view (btw, I recently found an old certificate of stock for Worldcom, just to give you a sense of what will happen to those shares). But what, for example, do you do with all of AIG's insurance liabilities? James Kwak covers some of the deeper issues here. It turns out that this is the more complicated issue, or is it? Sweden nationalized its trouble banks and guaranteed 100% of their liabilities. Apparently the real trouble question is how much trouble you create if you DON'T guarantee a nationalized bank's liabilities, because then nobody lends to banks and you have our short-term debt crisis all over again.

Whew. I'm getting a little worn out by all this.  I guess where I land with all this is that I support nationalization of troubled banks, and I feel that this is 100% compatible with my conservative tendencies, if only because it makes capitalists take responsibility for their humongous mistakes. The current bailout system seems more like crony capitalism, aka socialism.

The Fundamentals of the Economy are NOT Sound

James Kwak hits the nail on the head here. Even though there have been headlines for decades decrying the potential collapse of the Social Security system, a huge portion of Americans have not prepared at all for retirement.

And, yet, this does not surprise me. In my experience in loan underwriting and account servicing over the last few years, people are very poorly prepared. The existence of savings accounts, let alone financial planning, is just about non-existent. I would estimate that only one in five of the retirees that I work with actually have revenue from any kind of retirement savings, and usually social security amounts to the lions share of what they receive each month.

My friends and co-workers know that I'm a fan of Dave Ramsey. I am certainly not the archetype of personal finance, but I am convinced that most of my own personal problems were caused by my own lack of planning and willingness to charge it. When an individual, business or national economy tries to survive by leveraging itself all to H-E-double hockey sticks, then it really only takes one or two things going wrong to blow down your house (or economy) of cards. I watch my customers do this all the time. I have one family that is almost always 30 days late on their mortgage (they're not getting any principal reduction, btw), and we don't make a big deal out of 30-days delinquency, but they get shocked when I tell them that a lawyer is going to write them a letter if they don't get us a payment each month. I keep telling them, "You have to get this caught up, so that if something goes wrong, you've got another 30 days to work with." This is what we do when we have lots of debt - instead of saving your home equity for a real emergency, you use it to eat out every night for two years. And when the finance business tanks, you don't have anything to fall back on, because your house or business is leveraged out the ear.

On the flip side, my model for living is Exxon-Mobil (at least financial living). I bought some Exxon stock last fall when it had dropped to $75/share, down from $100/share. The number one reason: they can and do self fund their development projects. In this and any economy, I want to see that a company is running their house the way I want to run my house: you spend money after you've saved it. And you don't undercut your profits by paying out interest to some bank. If I make $100 doing something, I don't need to cut into my profits with finance expenses, and if the development project fails (which happens a lot in business), then I don't want to be caught with a debt AND a failed business.

Republican Disappointment

Prof. Krugman echoes my concerns about the Republican Party. I really do not see reasonable ideas coming out of that Party.

I was a gung-ho Republican back in my undergrad days, and I voted for McCain (a choice I'm not completely regretting, given Obama's phenomenal lack of leadership in this crisis). But the Republican Party had better come up with something, or they're going to find themselves outed from regions of this country besides New England.

Nationalizing Banks

My first question: Why would we nationalize a bank? What do we accomplish by that?

I understand that the FDIC insures a bank and needs to take over to make sure that depositors have access to their funds, but that's not what economists and policy makers seem to be discussing. I would like to understand this better.