Does Creeping Nationalization Make Reprivatization Harder?

A New York Times article tonight, “U.S. Likely to Keep the Reins on Fannie and Freddie“, raises the specter that the mortgage giants may never return to private form. Frankly, we think that is not entirely a bad thing. Fannie and Freddie were originally agencies of the US government and were (sort of) spun out in the late 1960s, when their borrowings on top of Vietnam war funding made the Federal balance sheet look ugly. And in typical plus ca change, plus c’est la meme chose fashion, the reason the GSEs have not been fully taken over is to avoid consolidating their debt onto the Federal balance sheet.

The article takes the tack that Fannie and Freddie may never be reprivatized, and then suggests that the big banks that are increasingly coming into the government orbit may suffer the same fate:

Despite assurances that the takeover of Fannie Mae and Freddie Mac would be temporary, the giant mortgage companies will most likely never fully return to private hands, lawmakers and company executives are beginning to quietly acknowledge.

The possibility that these companies — which together touch over half of all mortgages in the United States — could remain under tight government control is shaping the broader debate over the future of the financial industry. The worry is that if the government cannot or will not extricate itself from Fannie and Freddie, it will face similar problems should it eventually nationalize some large banks.

Now the conclusion could prove correct, but the analogy is false. Freddie and Fannie are very different cases than the big banks. They were never truly private; that was a big part of the reason they were put into conservatorship. They came to depend on both very high levels of leverage (that is, they held paltry amounts of equity) AND funding at virtually the same rate as the US government. Even then, both Fannie and Freddie engaged in accounting fraud to burnish their numbers and justify more handsome pay to top brass.

In other words, this was a business model that barely worked even in the good days.

Now to the fate of the big banks. At first I had thought the stress test process was deeply cynical, that banks would be given phony marks to bolster public confidence (a dangerous game if they come apart anyhow in less than a year) or that the process would be used to show that the government was reluctantly forced into taking them over. The stress tests can lead to the government requiring banks to raise more equity, and if they cannot raise it from private sources, they will need to resort to Uncle Sam. Given the already depressed levels of big bank shares, any fundraising would be massively dilutive, and still carries the risk that the government injections at a later date will still largely take out recent capital contributions.

An even more sobering possibility is that Bernanke and Geithner believe that the current lousy state of financial markets is the result of irrational pessmimism. If the government throws enough liquidity at the market, animal spirits will return and all will be well.

Nationalism arrived at this way, call it reluctant nationalism, could well make reprivatization more difficult than the more traditional kind (think the FDIC receivership, except the government can’t dispose of the assets by Monday, so it has to keep them for a while, perhaps as long as a few years, to figure out what the highest and best exit strategy is for the various components). Why would that be so?

First, as a Wall Street Journal story last week on Citigroup illustrated, in the creeping takeover scenario, neither bank management nor the various agencies involved are clear on who has authority to do what. Now admittedly, if this process continues, that ambiguity may be reduced, but it seems intrinsic to the arrangement. Nationalization as takeout, by contrast, puts the government officialdom in charge and ought to involve changes in top management and the board.

Similarly, reluctant nationalization keeps the behemoth financial firms intact, while the “nationalization as takeout” version assumes stripping out of bad assets, and a possible breakup of the firms. One or both would reduce the size of the remaning entities, which would make it easier to find new management candidates (frankly, no one has demonstrated themselves to be capable of managing such large concerns, while there are more candidates to run smaller operations).

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  1. Anonymous

    I am sorry but there are some of us that call this corporate government arrangement by its proper name of fascism.

  2. just another social scientist

    Anonymous 12:12 am

    The real irony here is that, while this may be fascism by fiat, the powers that be are acting in every way possible to void the authoritarian underpinnings by deliberately handing the reigns over to “the market” via private corporate governance. They have utterly abandoned their role of overseer while fully backing the financial strategies of this elite strata.

    From what I understand the systemic issue is the fact that “the market” as they understand it does not exist, and that financial entities are acting in a manner which violates free market principles. In this instance there is no market solution, so calling government action fascist is somewhat meaningless. Nationalization, ironically, may be the easiest way for price discovery to occur, thus catalyzing market behavior rather than limiting it.

  3. Anonymous

    So since creeping reluctant nationalization doesn’t fix the problems, it leaves the entity permanently unable to leave the nest, and it’s just another pit into which more and more taxpayer wealth is poured, in one form or another, often secretly or by deception.

  4. Anonymous

    Ok, how about if we say that we have lost “rule of law” by the unprosecuted financial criminality instead of fascism. Rule of law used to be touted as a bedrock component of Western society…..not so much anymore or do we have a two-tier legal system aoong with our two-class society.

    Would a social scientist believe that this will rile the masses to DO SOMETHING?

  5. Anonymous

    I find it so odd that we even have conversations about this. It’s so obvious that the government doesn’t bail out small banks, nor does it bail out large non-banks (see, e.g., reluctance to bail out GM). So here’s a bold idea…bring back Glass-Steagall and also limit the size of banks and financial insurers. Is this too obvious a solution? Couldn’t some politician with huge approval numbers (hint, hint) just come out and say this, that we will have to break up these behemoths to protect ourselves from future black holes?

    I don’t believe the world is simple. I actually believe the world is complex beyond our wildest imaginations and our most powerful minds. But come on, allowing the credit of the country to be concentrated in institutions prone to making less than optimal decisions because of skewed temporal incentives is just stupid. Honestly.

  6. Anonymous

    While the neither fish nor fowl character of the GSE’s prior to their takeover may have been unsatisfactory making them a fully owned creature of Congress will be worse.

    So too will it be with major banks in the hands of the Congress.

    Their boards will be stuffed with defeated politicians looking for well paying sinecures ( Chris Cox at SEC e.g. or, God forbid, the next Rod Blagojevich)and social and political considerations supplanting economic ones in their operation.

  7. Swedish Lex

    “Does Creeping Nationalization Make Reprivatization Harder?”

    The current “fluid” approach to handling the crisis, to be too kind, is blurring everything. When James Baker turns Swedish, it is time to pay attention.

  8. marin belge™

    “Does Creeping Nationalization Make Reprivatization Harder?”


    The US has only one way to rebuild itself. Grassroots. From new. Anything like rebuilding old stuff will end up in cronyism at best. Proto-fascism at worst.

    Your French reader with “on the job experience” concerning nationalization during our socialist times, thirty years ago.

    Quite a bit concerned at this stage

  9. Anonymous

    I believe Bernanke and Geithner have reached a plateau of arrested development. You hit the nail on the head when you opined that Bernanke “romanticized” the previous economic period and hopes to return to that suboptimal status quo.

  10. Charlie

    “An even more sobering possibility is that Bernanke and Geithner believe that the current lousy state of financial markets is the result of irrational pessimism. If the government throws enough liquidity at the market, animal spirits will return and all will be well.”

    They have the virtue of being half right. In the real economy, what has happened. Housing prices crashed. Well, they needed to. People aren’t buying cars. OK, so 16 millions cars sold a year was excessive. There is tremendous overcapacity and we could go to 8-10 million sales a year with no problems. People aren’t buying other durables since they can wait a year to buy a new laptop. Big deal.

    Higher education, which is also widely inflated, and a major burden for the middle class, can be dealt with by more government student loans.

    We can exist nicely in this zombie state for a while. Tinker with the employment numbers so they don’t look scary.

  11. mmdonner

    we are in the same boat as always. the market folks rebel against receivership and demonize any gov’t intervention with the N word.
    but private money is not stepping forward to capitalize the banks..yet the same folks don’t want banks to be allowed to fail or AIG to go under…remember the howl of LB?? as the huge mistake of the decade.
    so, damned if they do and damned if they don’t.
    can someone tell me exactly what the markets would be satisfied with/by that will stabalize the financial system domestically and internationally….which all agree is the first prerequsite to turning the titanic around???

    and please..don’t just say no nationalization or private money only…if not N or receivership..then where will the money come from…or…say clearly…”let them all fail”
    Please tell me what will make the “market/kudlow/cramer” et al happy??

  12. reed1v

    pragmatic reality: most financial, real estate, and manufacturing sectors virtually bankrupt. without intervention, might as well kiss off the u.s. economy. not that intervention will be the solution, but there is no other solution. besides corporate america largely behind this last ditch attempt to crawl back from the abyss

  13. dunnage

    Think of it, the Big Banks obviously get to keep the Treasury under a new administration, yet can’t figure how to crawl out of their respective block boxes. Unique Black Boxes that all do the same thing. The Big Bank guys, hey not the traders – cause they’re nuts and therefore will survive anything you can do to them –
    got money but need Power, Pride, and Party Invites. Retire and go home to the wives. Not that they want to take everybody down with them, but it’s not like they really care either.

    So, like, privatize what? Endless paper debt is actually their asset; something that threatens all. The question is not how you bring them private, it’s how you get rid of current vested personages. Look at that group sitting in front of Congress – irreplaceable? Must be genetic derivatives graduating from dad’s school to take over after the worker bees straighten out the institutions and pay the bills. Progress. Now one does ponder the French Revolution.

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