Wednesday, January 21, 2009

The [US Bank] Nationalization Debate

By Felix Salmon on's Market Movers:

I'm very encouraged by the breadth and seriousness of the nationalization debate as it has unfolded in the blogosphere in recent days; Steve Waldman, at the bottom of his latest post, has done a sterling job of rounding up most of it in one place. (The post itself is excellent, too, and makes the important point that when we privatize a nationalized bank, we should do so in small-enough-to-fail chunks.)

So far there has been little indication that nationalization is being seriously considered by the Obama economic team, but as Obama said in his inaugural address today, curiosity is key value "upon which our success depends," and I do have faith in his team being open to all good ideas, rather than constrained by dogma.

Let me be clear in response to Jim Surowiecki, then: I am no longer making the argument, if I ever did, that "the only reason people are skeptical of nationalization is because it's 'un-American'." Much more substantive reasons are coming out, not least from Surowiecki himself, who today provides some more, which are worth responding to. Here are his first two:

1) Two years of financial crisis does not invalidate the general principle that private enterprise is typically better at efficiently allocating resources than government; and
2) the idea of the state literally determining which companies and individuals do or don't get credit is, even to a non-libertarian, at least a little troubling.

I quite agree that the private sector does a better job of efficiently allocating resources than government. The reason is very simple: if a private company allocates resources badly, it fails. A government, by contrast, can allocates resources badly indefinitely.

Right now, however, we're talking about too-big-to-fail banks: failure is really not an option. One look at their share prices tells you all you need to know about how good they've been at efficiently allocating resources. The question facing the government is what to do about those banks, given that the normal market disciplines cannot be applied.

Later on in the same blog entry, Surowiecki asks "what investor is going to be interested in putting up money to acquire a bank that has to compete with nationalized, and therefore subsidized, banks". There's an easy answer, which is that the banks are going to be subsidized in some form or another anyway, whether they're nationalized or not. And then there's a bigger answer, which is that lots of investors have made very large amounts of money by successfully competing with state-owned banks. I spent many years covering the Latin American banking sector, where there are many state-owned banks, and where invariably those state-owned banks lose lots of money even as their privately-owned competitors are highly profitable.

Surowiecki's second argument, about the state determining who gets credit, comes rather late: we crossed that bridge when we took Fannie Mae and Freddie Mac into conservatorship. What's more, while a state-owned bank can certainly determine who does get credit, it can't possibly determine who doesn't. And the state often lends money -- as does the Federal Reserve, in unlimited quantities, to private banks. If the state can happily determine that banks should get credit, why can't it do the same for other borrowers? As Surowiecki himself concedes, "the government is already intimately involved in controlling the flow of credit". And it will continue to be so whether banks get nationalized or not.

Surowiecki then follows up with a second post on the same subject:

Many of the proposals for bank nationalization seem to imply that regulators should start declaring banks that are technically solvent (like Citigroup) insolvent, with the government getting to take all of the banks' assets as a result of what regulators decide... This, at the very least, does seem like it creates room for political mischief. More important, having the government take over going enterprises will encourage investors to put their money in one of two places: mattresses or government bonds.

Surowiecki should take a look at what the FDIC has been doing for years: exactly what he describes here. By "technically solvent" he just means that loans haven't been written down to their market price -- denial, basically, on the part of the bank's management. If a bank is actually insolvent, the FDIC steps in, and either takes control of the assets itself or, more usually, finds some other bank to sell them to. The FDIC has been in effect for a long time, now, and I haven't seen much evidence of "political mischief", and nor have I seen any indication that its existence makes investors less likely to buy shares in banks. Quite the opposite: the existence of the FDIC makes banks more valuable, since it makes it much easier for them to load up on cheap deposits.

None of this, of course, constitutes a reason to nationalize; it's just arguments against arguments against nationalization. But that's one of the things that's great about blogospheric debates: people spend some real time working on the nooks and crannies of ideas. And when there's an intellectually-curious administration in Washington, there's finally hope that those ideas and debates might end up being reflected in policy decisions.

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