Tuesday, March 24, 2009

"Nationalization" Or Buying Toxic Assets: A False Dichotomy

Furious debate has broken out over the Geithner Plan to use public-private entities to buy toxic assets from troubled banks. Advocates of "nationalization" say the plan is a payoff from taxpayers to the rich, and pose the Swedish plan as superior. But Sweden only nationalized one bank that had totally failed, and then only briefly, with another already state-owned bank getting recapitalization. Otherwise, the government simply guaranteed all deposits in banks. We have effectively already done the Swedish plan, with Indymac and AIG effectively nationalized, and guarantees on deposits increased. This sort of plan just helps the rich using taxpayer funds, just as does the Geithner Plan. These are both ways of using taxpayer money to pay off the rich, who have largely already taken a hit due to the collapse of bank stock prices.

So, the real alternatives would be a true nationalization that would keep ownership and take over management of the banks. This will not happen in the US. The alternative, which is sort of what we did with the S&L crisis, is to liquidate the troubled banks and pay off the depositers. However, the FDIC is not remotely able to do this, even with the $500 billion loan it received in the stimpack. The S&L thing "only" cost the taxpayers $175 billion 20 years ago, and while we think of depositers as "regular folks," the people with the really big deposits tend to be (hack, cough) rich people. Anyway, this is not likely to happen either.


Anonymous said...

Geithner’s plan is siphoning plan

Geithner’s plan is worse than Pualson’s plan because the plan will definitely cause over-pricing assets purchase and also cause the siphoning from taxpayers’ money into banks and Wall street investors, definitely worse than Madoff ponzi scheme. Why? We are allowed the assets sellers-Wall street investors (Banks, Hedge funds and all kinds of funds) can join in the program to buy assets. They can be both buyers and sellers and they can set up groups of buyers to bid the assets at the over-price and the loss will come to taxpayers’ money. For example, the intrinsic value of asset at 100 dollars but the sellers and buyers are the same Wall Street investors such as CITIGROUP, JP Morgan of BofA. They definitely want to buy like 150 dollars meaning they will gain 43 dollars (gain from assets sales at 50 dollars but loss from private capital investment at 7 dollars) but the tax payers’ money will lose 43 dollars from the public capital at 7 dollars and the FDIC guaranteed bonds at 36 dollars. Therefore, Geithner’s plan is siphoning plan from taxpayers’ money into the banks and Wall Street investors. If the total plan is 1 trillion dollars, we could expect the loss up to 300-400 billion dollars if they allow Wall street investors to join buying at 40-50 % over intrinsic value. Therefore, we should reduce conflict of interest by not allowing the sellers or the investors who are holding the assets to join buying assets in the program.

Why depression occur from government’s reckless intervention

Another point I would like to explain why the economic situation is getting worse to depression if the policy makers transfer the loss from the private investors to taxpayers or we call it as the severe cost of intervention. We have to understand that the private investors/speculators hold the risky assets under risk management plan that they can get loss from investing; however, the taxpayers do not have the plan or risk management for the loss on investment. Therefore, when the government intervene the market and get loss (we are definitely facing the increasing loss of FED and FDIC and we could expect to see more under reckless Geithner’s plan), it is like money transfer from private investors into taxpayers and taxpayers will have to compensate the loss by higher taxes and higher cost of living such as the higher inflation or higher cost of fund such as the higher long-term government bond yield. I think the worst case scenario is not recession with deflated price but the depression with hyperinflation because there will be the wealth destruction to consumers and taxpayers not free lunch private investors or producers. I think every country face the same problem; all the loss going to taxpayers but all the gain going to investors and producers and this is the real crisis of economic sustainability and the huge burden to the next generation.

Eleanor said...

Barkley -- Are you satisfied with the current situation? Is there something you'd prefer to see?

Anonymous said...

Nationalization comes with wiping out bondholers who made bad investments. I believe the taxpayers become the new bondholders. AIG bondholders were partially bailed out.
Nationalization also brings new management that doesn't replay this incident next business cycle when the US government might be paying 10% interest on its 2018 stimulus package to bail out idiots.

Nationalization means the public gets the upside and the downside. This is just rape.

Anonymous said...

This is a national emergency. Make it happen! Of course these banks are bigger than the FDIC has taken over before but the US Government could use emergency powers to get the job done. The US Government wouldn't think twice about doing something "impossible" if we were invaded no matter which of my rights they had to squash to do so. The same applies here to the banks that have violated our economic sovereignty. You also, completely "forget" to mention that in a nationalization, just like in real capitalism where businesses are allowed to fail prevents moral hazard while bailing out investors and retaining bad management does nothing of the sort.

Peter Dorman said...

OK Barkley, I'll bite. This is a little tricky to parse, since the word "nationalization" is used in different ways, with very different implications. Also, FWIW, I am not an advocate of nationalization, so maybe I can make the case more dispassionately.

There are some people on the left who get goosebumps when they hear the "n" word. They are a sad echo of a once-proud socialism. I read the rapturous visions of a nationalized financial system in The Nation and weep for the world we have lost -- but this has little to do with anything that's actually on the table.

More thoughtful nationalizers have this in mind: (1) Wipe out the shareholders. (2) Throw out the managers. (3) Seize the books. Don't accept mumbo-jumbo about the banks' financial condition. (4) Systematically deal with all liabilities: resolve obligations, satisfy/trim the bondholders, etc. Do it quickly. From this point of view nationalization is less about taking an equity stake than performing a set of housecleaning activities. The other thing is that, in seizing the banks, the government acquires both the good and the bad assets, increasing the likelihood that they can sell off the whole thing later on for not too much less than they shelled out. If you buy only the bad stuff you are unlikely to come out very well.

So, I would say I have to disagree with you on this one. Nationalization is different. I think we can do much better than that, but I would agree with the critics that nationalization is better than the current approach. A return to the glory days of socialism it's not, however.

rosserjb@jmu.edu said...

Young Economist,

Well, the degree of overpaying for assets will depend on the degree to which they are currently under or accurately priced and how these buying entities get set up. You are certainly right that there is a serious danger of overbidding for these assets.

OTOH, pretty much any of these schemes aside from full-out, real, nationalization (not the de facto receiverships a la Sweden that are getting called "nationalization") essentially involve taxpayer money, directly or indirectly, being pumped into the banks. After all, how does one "recapitalize" a bank in deep doo doo? One pumps money into it one way or another. So, in fact I think the inventors of this plan fully expect to buy some of these assets for "too much." This is how the recapitalization is to happen that some critics of the plan say is lacking and needed.


I do not know. We have a very bad situation on our hands, very bad indeed, and I am one of the ones who was warning quite some time ago that very bad things were going to happen due to the housing bubble and the related surge of exotic derivatives. It does not make me particularly happy at this point to crow too much about being right.

So, hopefully it is clear that I think we have a choice of a bunch of plans that are all flawed. To look at the two extreme ones, full-bore and permanent nationalization threatens to lead to corruption and inefficiencies, as we have seen in many countries (including supposedly capitalist ones like France).

OTOH, I fear full-bore liquidation and payouts. Quite aside from the FDIC being overloaded, I fear ripple consequences of having big banks shut down. People are sneering at the "too big to fail" concept, but that is what made the Great Depression "great," the massive, global wave of bank failures that was triggered after the Creditanstalt failed in Vienna in May, 1931. I remind that when these problems first began to surface in August, 2007 as the US subprime mortgages began to blow up, it was some European banks nearly failing that triggered the perception that we were in a crisis situation.

So, no easy out, a bunch of bad choices (and I think the market went up yesterday basically because there was finally "a plan," for better or worse).

Phillip Huggan,

Well, we are back to what was one of the major points of my post: that there are a wide variety of policies that are called "nationalization," and that what Krugman and others are using that term for should really be called "receivership," or something along those lines.

So, maybe bondholders are wiped out and maybe they are not. Maybe upper management is fired and maybe it is not, and even if it is, there is clearly a discretionary decision about how far down into the corporate hierarchy one wants to define "upper management" to be. And there is even a variety of how stockholders are handled: are they bought out at some price (and what price), or are they simply dispossessed (bought out at zero price)?

And again, with let us say, the most punitive and draconian of nationalizations: liquidate all the bond and stock holders and fire the entire staff, and do not reprivatize, one then gets into all the moral hazard and "soft budget constraint" problems with a nationalized bank. One ends up with a Credit Lyonnais or Societe Generale going to the government for endless handouts as the schemes forced on them by corrupt politicians go bad, and so forth. There is an idealistic pollyanna view of how "socialized" banks will do all these good things, but this only rarely works out in reality.


Sounds like you favor the liquidation scenario. See above comments.

Anonymous said...

Nationalization. Pay creditors for the good assets, then recapitalize as the people's bank.

Take illiquid securities and warehouse them, to be worked over and out over time. Don't prepay anyone anything for this stuff. No need to. Pay creditors for whatever the stuff turns out to be worth. Which will be more the longer they stay warehoused, right?

If it's a Citi type of bank, split off the non commercial bank asset (investment banks) and give that to creditors. Wish them "good luck," and show them the door.

As for bank property, we've already overpaid for that with TARP funds. Deposits are transferred no charge. It's already the people's money.

Anonymous said...

"Maybe upper management is fired and maybe it is not, and even if it is, there is clearly a discretionary decision about how far down into the corporate hierarchy one wants to define "upper management" to be."

Anyone who was aware securities based on the premise USA real estate prices would grow 20% indefinitely, and were being hype as AAA, and did not whistle blow, should be fired and certainly should not be rewarded (1-10% of staff??). It is very easy to find out who these employees are. People who have lost their life savings are vocal and don't mind naming idiots.

This will happen again because the precedent has been demonstrated yesterday all you have to do to collapse America is fudge accounting or invent a false view of one's responsibilities that is too complex for a regulator to pin.

You don't get your bonuses docked (obvious now in 2009 nations that enshrine property rights in their constitutions are a failed model). You don't get reprimanded. You don't get barred or fired. You don't get arrested. You get rewarded at a level beyond the wildest dreams of those who lost their lifetime savings not knowing real estate doesn't ever increase at 20% over the duration of an individuals pension and savings withdrawals.

rosserjb@jmu.edu said...

Phooey, just wrote a long comment that somehow did not post here. So, shorter as need to go to a meeting.

Peter D.,

Why hose the stockholders but not the bondholders?

Yeah, I would like to throw out the old managements, and at some banks they are gone, although new ones under nationalization are not going to be too keen on getting treated to speeches about suicide as the government-appointed AIG CEO Liddy was some few days ago.

Sure, would be nice to have better accounting, but much of the problem is that nobody knows what some of this stuff is worth, and may not be able to know easily under any setup.


No guarantee stuff is going to improve in value with "warehousing."

OTOH, I am for breaking up some of these banks, probably a better approach than half-baked, so-called "nationalization." Keep them from getting to be "too big to fail."

Philip H.,

I doubt that it is "easy" to find who in upper middle managements "knew" but did not whistle-blow. They were silent, but were they ignorant? Many knew, but they were in environments where they certainly would not get promoted and might even get fired if they rocked the boat. If they were not in charge, what is the point of punishing them now?

Anonymous said...

Maybe you're right and there is no point.

Anonymous said...

This article offered an intriguing take on how the economic crisis is being handled. It also gave a unique perspective into how other countries have experimented with nationalization, while stressing the fact that their attempts are not always successful.

Anonymous said...

Man the debate in the US is crazy. NATIONALIZE the banks: wipe out the bondholders and the shareholders and honor the depositors. Then do robust regulations with solid capital requirements so that trust can be rebuilt.

When the banks are good and healthy off-load them onto private investors and pay down your debt.

It is a slam dunk from the outside--non-tempered by ideological and political reality: but I have faith, American pragmatism always wins out over ideology right? right? right?.....

Myrtle Blackwood said...

"People are sneering at the "too big to fail" concept, but that is what made the Great Depression "great," the massive, global wave of bank failures that was triggered after the Creditanstalt failed in Vienna in May, 1931.

What made the Great Depression 'great' was the lack of options for a large number of ordinary people once they lost their jobs. If a lifestyle based on obsessive production for obsessive consumption disappears, what do we have left?

..Many knew, but they were in environments where they certainly would not get promoted and might even get fired if they rocked the boat. If they were not in charge, what is the point of punishing them now?

And the Nuremberg trials were just a show, eh?

Anonymous said...

Barkley Rosser:

If you long foresaw this coming,- (and I don't doubt that you did, though not uniquely)-, then perhaps you should have bent your considerable intellectual resources at figuring out a resolution regime, rather than wanly poo-pooing the alternatives on an ad hoc basis. Me, I first broached the issue of bank nationalization on 04/05/08,- (since I googled myself a while back and was surprised it was so early, thinking I'd started on the meme at the end of May),- wherein I called it "the Norwegian solution",- and I wonder why the "Sweden" meme has taken hold since, since the Norwegians were much tougher. But there are two key points to nationalization/public receivership schemes. One is that they need to be prepared in advance, with a well-conceived legal and procedural regime in place, and fully staffed with technically competent personnel. And the other is that the bond holders should not be guarantee, but rather, to the degree that losses are not fully recovered from wiping out the equity, there should be forced conversions of bonds to equity, to the extent required in each case, and the equity consigned to a "bad bank" holding facility, to be repaid pari passu out of whatever eventual recoveries. Insofar as bond holders' losses involve further collateral damages to pension funds and insurance companies, that issue has to be researched before hand and further assistance will be required to repair that specific damage, which will add to the cost, but no other bondholders should be accorded any extra consideration. As to the bank being publicly owned, well, fire-walls can be erected between professional managements, appointed by on oversight board, and any overt political interference,- (and why should one believe that they would be less effective than those already involved in regulatory oversight, but rather more so, insofar as the lobbying of profit-minded managements would be abated?) In the meanwhile, a new regulatory regime for banking and finance could be developed and put into place, including the breaking up of large banking oligopolies as too-big-to-fail, which might well include, yes, some role for publicly owned banks, as public utilities. Only after such a clean-up, recapitalization, and re-regulation should banks be sold off piece-meal and as opportunity allows to private sector investors. Needless to say, banks that are not in any degree insolvent would not be subject to such a regime. But it seems clear to me that such an approach would be the most functionally efficient, cost-effective, and economically conducive,- not to mention equitable- approach to the crisis of the financial system. Yes, up front and explicitly, it would be the most costly, but long-run the least costly. (Simon Johnson estimates it at $3-4 trillion upfront and $1 trillion net, though I've no idea where he came up with those numbers). I'd further add, that the losses on re-privatization should be added to, because we would want a down-sized, less dominant financial sector, and a less "profitable" one, with high capital ratios/lower leverage. The only thing that actually stands in the way, reactionary, ignorant and corrupt politicians aside, is precisely the ideology that the private sector is always more economically efficient and the concomitant desire to attract private investment for re-capitalization. But needless to say, that has come under a practical test and proved wanting. As to how to pay for the long-run fiscal cost, a net worth surtax on millionaire households, for as long as necessary, would be my preferred approach. That that would dampen financial asset "values" and reduce the desire to speculate is all to the good, IMHO.

Barkley Rosser said...


One improvement of today over that past time is that we do have much more extensive social safety nets than we did. This is something that is easy to take for granted, and there have been many who wanted to shred these nets. But, fortunately they did not succeed.

Um, I think there is a rather large difference between failing to whistleblow on bad loans and being part of a chain of command involved in mass murder on the scale of millions of people.


Interesting observations. I am hoping the current plan by Geithner and crew works, but I am not at all sure that it will. I disagree with Krugman that this is the only chance to do it. For the obvious ideological reasons, partly associated with the somewhat distracting use of the "n" word in this context, there is much opposition to nationalization in the US Congress. But if the currrent plan fails, that means that things in general will get much worse. Then Congress would be open for something more drastic.

As it is, I understand that some of these things were seriously considered, including the idea of a "bad bank," which was in effect what the RTC was during the S&L crisis. They may be wrong, but the argument by those in the administration has been that what is involved here now is far bigger than anything in Sweden or Norway or the S&L crisis. No "bad bank" would be big enough to handle all that crud, and the banks involved are very large.

It may not have been all that hard in Norway to get trained personnel to take over running those banks, but outfits like Citi and BOA are really huge and running them is a much more serious proposition, one I can understand they would prefer to avoid if they can manage it. We shall see if they can or not, but I do not think we are hopelessly locked out of the nationalization option if we really need it as Krugman is arguing.

Myrtle Blackwood said...

"...I think there is a rather large difference between failing to whistleblow on bad loans and being part of a chain of command involved in mass murder on the scale of millions of people."

It sounds like a reasonable statement. But evil looks pretty banal from where I sit.

Hundreds of thousands of workers laying the bricks to construct gas chambers and concentration camps one after the other. Day after day. 'Universal soldiers' going off to fight "for their country' by bombing foreign city after city. Helicopter pilots dropping tonne after tonne of toxic residual chemicals over thousands of rural communities....

Where would you draw the line, Barkley?

href="http://news.bbc.co.uk/2/hi/americas/7585696.stm">One of millions of 'financial crises' victims

Myrtle Blackwood said...


rosserjb@jmu.edu said...


Well, the issue is the underlying crime. Genocide is about as bad as it gets. Financial fraud is not nice, but it is nowhere near being in the same league as genocide.

To top it off, the would-be whistleblowers were in a situation where they did not know for sure that the financial arrangements they were involved with would actually blow up. It was all a matter of "maybe" and "might happen" or at most "very likely to happen," but not the same thing as "the trains are carrying the victims to the concentration camps where they are being gassed to death in an assembly line fashion as we speak."