Greg Mankiw today addresses an issue which has been nagging at me, but I have neglected to address. I’ve gotten a fair number of comments along the lines of “I’m opposed to bank nationalization, but I agree we need to do something, so put them in bankruptcy.”
Aargh. No one seems to have a problem with the FDIC shuttering bank, selling deposits and assets, and figuring out what to do what’s left over. Folks, that is a form of nationalization. What most people fail to recognize is that the FDIC tries to minimize how long it is in control. The reason the US had to resort to a bad bank in the S&L crisis was the FDIC and FSLIC had so many dead banks landing in their laps in a compressed time frame, and in particular, banks with some assets that were hard to value (think largely vacant new office buildings in Texas) that the regulators had to get extra funding to deal with the mess and come up with a variant of their usual routine to encourage other buyers to look at some of the bank assets.
The problem is that the procedures that work for small and even fairly large banks do not work for super big banks (so who would buy Citi’s deposits and branches, pray tell? And even if such a bank existed, do we want that much concentration? And what do we do with the junky assets, the private equity portfolio, the asset management business, its credit default swaps book, its various trading operations (many, ranging from FX, Treasuries, structured credits, money markets instruments, equities, junk bonds, derivatives, and I’m sure I’ve missed quite a few). These banks are not simply bigger; they are in a far wider range of businesses than the typical FDIC basket case, with a much larger geographical footprint (typically substantial foreign operations) and more complicated operations (meaning management information systems, financial reporting, transaction processing, customer reporting, risk controls).
It’s hard to convey to people outside finance why a big complicated bank isn’t the same as a manufacturing business or a retailer, where you can resort to Chapter 11. The simplest explanation may be that banks are much more tightly integrated into various customer and counterparty webs than most other businesses are. If a big automaker wants to shut down a production line for a few hours or a week. it can be done with little disruption to outside parties if planned. It isn’t acceptable for a trading desk to shut down for a day, say to do “routine maintenance”. Counterparties would run for the hills the next chance they had a chance to initiate trades. Now one might argue that this is convention, but as a customer, not being able to trade, not having ready access to one’s funds is seen as an unacceptable risk, and that business requirement makes it impossible to resort to Chapter 11. By definition, creditors are held at bay. That means they CANNOT access their positions (certain changes that were part of the 2005 bankruptcy reform in fact allow certain parties preferential rights, but enough are at risk of being frozen in Chapter 11 that credible information that a trading operation is going down is enough to precipitate a run, as happened with Bear).
I know that that is a gross oversimplification of the procedural issues, but I believe it conveys the essence of the problem.
Mankiw thus favors nationalization, or what he calls, following Calculated Risk, “pre-privatization”, as the best fudge we can come up with in lieu of having a regulatory/bankruptcy regime that addresses the peculiar nature of large, possibly systemically important, trading organizations.
Why are people scared about the idea of nationalization? One reason is that it is a sign of the depth of our problems. A second, more substantive reason is that it seems to point in a bad direction. I certainly do not want the government deciding who deserves credit and who does not, what kind of investments are worthy of financing and what kind are not. That is a big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.
If the government is to intervene in a big way to fix the banking system, “nationalization” is the wrong word because it suggests the wrong endgame. If banks are as insolvent as some analysts claim, then the goal should be a massive reorganization of these financial institutions. Some might call it nationalization, but more accurately it would be a type of bankruptcy procedure.
Bankruptcy could become, in effect, a massive bank recapitalization. Essentially, the equity holders are told, “Go away, you have been zeroed out.” The debt holders are told, “Congratulations, you are the new equity holders.” Suddenly, these financial organizations have a lot more equity capital and not a shred of debt! And all done without a penny of taxpayer money!
One of the problems in talking about nationalization is there is very little consensus on what the word means, Indeed, in reading the press, columnists, fellow bloggers, and comments, I can see a wide range of assumptions, hidden and explicit, at work. The more we start clarifying what we mean, the better chance we have of sharpening debate and coming up with viable approaches. And I strongly suspect, as Mankiw suggests, that the advocates and opponents may have a lot more common ground than they realize.