Nationalization: Arguments Against … Sort Of
Straight from Paul Krugman: Anti-nationalization arguments – Paul Krugman Blog
The opposition to nationalization breaks down very quickly when it relies on purely financial or economic arguments. Krugman has been relentless in articulating this, so I pass on this link to help spread the word.
I can understand, although not sympathize with, an ideological anti-nationalization argument. That at least is coherent. The arguments I have a hard time with are those that try to fudge around the good bank/bad bank concept without acknowledging the hugely asymmetrical nature of the consequent economics.
Good bank/bad bank is designed exactly to protect the current shareholders from any further erosion in the value of their capital. The idea is to isolate all the toxic assets in a new entity set up for the purpose of working down the bad assets and ultimately absorbing any losses that accrue from them in a separate legal entity apart from the original bank. The flip side is that the new ‘good bank’ can go ahead with business, make loans and profits as if the bad assets no longer exist.
But, as Krugman clearly points out, this separation has to be done so as to balance both sets of books: you can’t just hive off assets [good or bad] without similarly hiving off, or receiving fresh, liabilities. That’s the thing about accounting, it doesn’t allow that kind of cheating. So, if you set up a bad bank with lots of awful assets you have to have an equal amount of liabilities. The implication of the bad bank advocates argument is that the taxpayers provide the necessary liabilities in the form of a capital injection.
And that’s where I have a problem. By pulling the bad assets out and making them the responsibility of the taxpayer via a bad bank, we have inoculated the old shareholders from any losses. They only get gains. This is flat out objectionable.
Proper nationalization avoids this by allowing taxpayers to share in the gains as well as be responsible for the losses. It also wipes out the wealth of the old shareholders by eliminating their capital in the nationalized bank.
The oddity here is that this form of reorganization – temporary nationalization is just a different form of bankruptcy – is entirely consistent with the good old fashioned capitalism that the good bank/bad bank advocates seem to be trying to protect. The old shareholders are forced to pay for the risks they took in full. The new shareholders, i.e. the taxpayers, get both the losses and the gains due to them as new owners; and, ultimately, when the banks are privatized the investors who buy their stock will be forewarned that taking risks implies taking losses as well as gains.
What’s wrong with that?
Another ant-nationalization argument is more legal/accounting than economic. It revolves around the way to pay off or eliminate the liabilities banks have to bondholders. These bonds are usually in the form of ‘subordinated debt’. In bankruptcy debtors are paid off in order of their ‘seniority’. This, in turn, depends upon the nature of the debt they own. In general debt that is senior has lower interest rates in return for more security. So called ‘junior’ debt has less security, i.e. it is ‘subordinated’ to and more risky than senior debt, and thus commands a higher interest rate. Junior debt holders get to be a problem in bankruptcy because they are next in line to absorb losses once the equity holders are wiped out. In practically all the banks being talked about as nationalization candidates there would be no equity so the junior debtors will also have to lose something. Whereas they took debt to be more secure than equity they now find themselves with the same risks as the eliminated equity holders. This rarely sits well, so a legal fight breaks out and the bankruptcy screeches to a halt while compromises are worked out. That’s what bankruptcy courts and judges spend much of their time on. In the case of the government nationalizing a bank there would be no bankruptcy court to arbitrate easily, and so the subordinated debt holders loom as a stumbling block to a smooth takeover.
As I said this is a legal issue.
But it dopes not invalidate the benefits of nationalization. Certainly the government wants to avoid endless litigation from a bunch of irate bondholders, but that is a separate problem from that of fixing the banks themselves. Bondholders should not be allowed to hold the country up to ransom. In a realistic accounting sense, their holding are already diminished in value: a private bankruptcy would inevitably involve a loss to the bondholders. So imposing some form of ‘haircut’ on them seems both obvious and fair. It does not represent an insurmountable obstacle as a basis for objecting to nationalization.
Still, the discussion roils on. I must admit to a growing frustration that so much energy is being spent on finding ways to circumvent nationalization. There have been many variations of good bank/bad bank floated and they all fail the fairness to taxpayer test. All the other so-called stumbling blocks are artificial and, when analyzed, without merit.
Nationalization is the one plan we have that we know actually works. Why we aren’t getting on with it is beyond me.
Addendum:
Add this discussion at the Baseline Scenario to the list: Baseline Scenario: McKinsey Plan The McKinsey plan is a good example of missing the point. It is what we would expect from very bright and well intentioned bureaucrats. Its contribution is toward resolving the pricing of assets so that they can be transferred. Remember that fixing a ‘market’ price for those assets has been a big issue in their transfer into a bad bank, so the McKinsey folks look like they’re helping by giving us a method for setting a price. The problem is that fixing a fair or market acceptable price is a big issue for the good bank/bad bank advocates, it still does nothing to correct the essential, and my mind deal breaking issue, of fairness to taxpayers. Technical wizardry is not necessarily sensible thinking.
