Brad DeLong made my day:
Nationalization has the best chance of avoiding large losses and possibly even making money for the taxpayer. And it is the best way to deal with the moral hazard problem.
It might work like this. Congress:
grants the Federal Reserve Board the power to take any financial firm whatsoever with liabilities and capital of more than $25 billion that is not well capitalized into conservatorship
requires the Federal Reserve Board to liquidate any financial firm in its conservatorship when it judges that the firm is insolvent (paying off in full or not paying off in full the liabilities of the firm at its discretion), unless the Federal Reserve Board finds that preservation as a going concern is in the interest of the taxpayer, in which case Congress grants the Federal Reserve Board the power to transform equity stakes in the firm into junior preferred stock at par value and then transfer ownership and custody of the firm to the Treasury
requires the Federal Reserve to terminate conservatorship if the firm becomes well-capitalized once again.
In addition, Congress:
grants the Treasury the power to issue up to $500 billion of troubled asset redemption bonds, the proceeds of which are then to be loaned to the Federal Reserve to be used to cover the liabilities of those liquidated firms that the Federal Reserve judges it is in the interest of the taxpayer to have their liabilities paid off in full.
...It's time for the Democrats to pass a nationalization in the taxpayers' interest bill and dare Bush to veto it.
There's a beautiful irony here. The superficially private-sector-friendly Paulson Plan is likely to entail socializing losses and undermining the incentives that give capitalism its efficacy and its legitimacy. Outright nationalization, on the other hand, may look like a Commie statist plot, but strengthens the "invisible hand" in the long run, as long as the nationalization is temporary.
To understand the paradox, go back to Zingales' excellent essay. Under ordinary circumstances, when firms can't manage their debt, Chapter 11 reorganization is an excellent means of preserving market discipline while preserving the "going concern" value of the enterprise. Unfortunately, bankruptcy is a slow and uncertain process. In the current crisis, the insolvent enterprises are so large, numerous, and interconnected that financial markets might self-destruct if we "let nature take its course".
Temporary nationalization could serve as a kind of fast-track bankruptcy. Creditors, counterparties, and customers would have some certainty that firms in conservatorship would continue to function, and most could expect to be made whole (although the state could and should force haircuts or debt-to-equity conversions on the some junior claimants). Stockholders and incumbent management would be unceremoniously booted from nationalized firms, creating a strong incentive for companies to avoid the state's tender mercies if at all possible.
Besides reassuring counterparties, nationalization provides an opportunity for the government to restructure firms prior to reprivatization with an eye towards reducing systemic risk. "Too big to fail" firms can be sold off in pieces, rather than merged into superbehemoths with a government-arranged subsidy, as is the current fashion.
Of course, nationalization does represent a "taking" by the government of private sector assets. The salutary effect with respect to market discipline has to be weighed against a corrosive effect on property rights. But if the terms under which firms can be nationalized are reasonable and carefully spelled out, especially if nationalizations generally occur where firms otherwise would have fallen into bankruptcy, the harm to property rights would be minimal. Also, procedures and timetables for reprivatizing or liquidating nationalized enterprises would have to be built into the plan.
Nationalization is a hard sell politically. Small government, free-market types naturally have a problem with the Feds coming in and taking over stuff. But counterintuitive though it may be, overt nationalization is more consistent with the principles of a free market than covert government subsidy. Real capitalists nationalize.
- 27-Sept-2008, 2:oo p.m. EDT: Changed "let nature taking its course" to "let nature take its course". Fixed spelling of "mericies".
|Steve Randy Waldman — Saturday September 27, 2008 at 4:09am||permalink|