Nationalization Once More!
Well, the dramatic fall in bank stock prices is pushing us closer to the day of reckoning when American policy makers will have to face the prospect of full nationalization of at least one, if not two or three, of our largest banks. I have been beating this drum for a while and want to keep the pressure up because I believe strongly that nationalization is the quickest, cleanest, and ultimately cheapest way to get the credit markets cured and working again. Here’s yet another link of resources for you to read through. Once again my source is Paul Krugman and thence the Financial Times: Financial Times: Nationalisation linkfest
Some of you appear taken aback by the very word ‘nationalization’ as if it portends the end of the universe, or at least the end of the good old US of A. There seems to be something almost dirty and certainly ‘unAmerican’ about nationalization as if only those failed Old Europeans do that neo-socialist stuff. Us healthy young Americans don’t resort to socialism.
Nonsense. And poppycock.
First: the nationalization would only be temporary. It would be for a two or three years, or as long as it takes to knock some sense into the banking system.
Second: many of our major banks are already ‘technically’ insolvent on a market value basis, and are only avoiding actual bankruptcy by hiding behind the increasingly thin veil of historic cost accounting. That’s like arguing a corpse is still alive because it had a heartbeat yesterday. History means nothing in finance. The relevant question is what could you sell those assets for today. If the answer is ‘not much’ or ‘less than my liabilities are worth’ then you’re bankrupt whether yesterday’s asset values were golden or not. One of the major issues in the credit markets at the moment is that all those toxic real estate assets are still tough to value. No one knows what they’re worth. And if they still represent a large chunk of a bank’s balance sheet, as they do in several cases, then we also don’t know what the bank is worth. Toxic assets are an anathema to banking because it undermines the inter-bank market: banks can’t lend to each other when there is no confidence in asset values … where is the cash coming from to repay the loan? People beholden to shareholders don’t take those risks. They protect themselves. Countries with printing presses to manufacture money don’t have to worry so much about the niceties of interbank credit. Hence the attraction of nationalization: it frees banks up to lend again.
Third: following on from this is the criticism leveled by Willem Buiter, whose comment is buried in the list of links I have given you above. He points out that giving banks cash in the form of only partial ownership is actually creating an incentive for them not to lend. This is because the banks are given an incentive to hoard cash in order to pay back the government at the earliest moment. So instead of using the capital injection to recommence lending, the banks, perversely from a policy perspective, stop lending and hang on to the liquidity in order to get the government out of their hair more quickly. The capital injection, if it brings only partial ownership, halts lending rather than encourages it!
Fourth: asking private banks to get on with lending right in the middle of an economic downturn is also perverse. There is a high probability that loans made now have an above average default rate because of the weak cash flows and poor economic prospects that borrowers have during recessions. So lending now would create more credit losses down the road. Naturally banks want to avoid that, so they shut down or minimize lending until there are signs of an economic recovery. Nationalization relieves this problem because the government is less worried about future loan losses and is more focused on getting the recovery going by making credit available. Again: governments can print whatever money they need to replace any losses that may emerge.
In normal business cycles the government is able to fire up the credit availability simply by lowering interest rates. When money costs less to borrow even risky projects can make money [the cost of capital is the key component in measuring the return on a project], and so businesses can find lenders willing to make loans.
But this is not a normal business cycle. Interest rates are so low that they cannot be lowered sufficiently any more to loosen the credit market. this is the cost we are paying for the mismanagement of the Federal Reserve Board throughout the last ten years. Interest rates were kept artificially low for years even while the real estate bubble was emerging. Asset price inflation was completely ignored and we were told that the market would take care of itself.
Well it did.
And it’s taking us down too.
So without any normal levers to pull to get the credit markets running again, and with an unprecedented asset bubble undermining asset and bank balance sheet values, we are faced with an unholy mess. The only credible solution is direct intervention.
Nationalization of a few large banks, say Bank of America and Citibank, would instantly relieve pressure in the interbank markets; it would free those balance sheets from the straight jacket of recovery and put them to use as sources of credit. Once the economy recovers the assets that currently have an uncertain value [and are therefore inhibiting credit growth] could be sold off since their values will be more reliable in a the, then, more stable conditions. The resulting cleaned up banks can then be auctioned off back into the hands of private shareholders.
Why is this so difficult to grasp?
