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.