It will come to no surprise of readers of this blog that I favor nationalization of failed, systemically important banks. But James Surowiecki and Floyd Norris have a point. We absolutely should not nationalize as a means of persuading banks to issue credit more freely. If the government (idiotically) wants looser lending than banks are willing to provide, it oughtn't take their money and lend it. The government can lend its own damned money (well, our own damned money) if it thinks that profitable loans are not being made, or that for the good of the economy unprofitable loans must be made.

The reason to nationalize a bank is because the bank has failed and its former owners have no legitimate claim to its assets. The government has been forced to offer support with public money, thereby purchasing the corpse fair and square. We take the bank into public ownership because taxpayers who have been conscripted to accept extraordinary losses are entitled to whatever gains follow the reorganization they finance.

When a bank is nationalized, shareholder equity should be written to zero, and existing management should be handled as roughly as the law allows. If we have a bit of courage, we should impose haircuts or debt-to-equity conversions on unsecured creditors, but I don't think we have that kind of courage. "Toxic" assets should be revalued at pennies-on-the-dollar market bids or else written to zero and hived into "bad banks". Once we have a conservative valuation of the assets and know exactly what is owed, we'll know how much public money would be required to cobble a robustly funded bank from the wreckage. However, if we recapitalize "too big to fail" banks without restructuring them, we will quite deserve our next mugging. We had better cut these monsters into little, itty, bitty pieces. We should embed strict size and leverage limits into their itty, bitty charters, restrict their ability to recombine, and then hire management to run the little things on strictly commercial terms. Hopefully we will change what it means for a bank to run on commercial terms — We should create a tax and regulatory structure that penalizes scale and leverage across the board. Better yet we should decouple the payment system from risk investment by reorganizing banking functions into "narrow banks" and credibly not-guaranteed investment vehicles. But whatever the banking industry comes to look like, nationalized banks should be recapitalized once, then managed to compete in it, and for no other purpose. Taxpayers should seek to extract maximum value from their eventual privatization. But should any of the reorganized banks seek a second helping of at the public trough, they should be ostentatiously permitted to fail. Rather than an implicit government guarantee, successors of nationalized banks should face a particularly itchy trigger finger.

Having nationalized "banks" make loans that prudent managers of a well-capitalized bank would not make is just a way of obscuring a subsidy and ensuring permanent quasipublic status by requiring on-going guarantees, bail-outs, and capital injections. Further, putting easy-lending public banks in competition with ordinary thrifts would resuscitate the destructive dynamic we have just put behind us, wherein bank managers must match the idiocy of their most foolish counterparts or watch their businesses wither.

If we want to stimulate the economy, put idle resources to work, stoke animal spirits, whatever, we should do that with some combination of transfers, investment subsidies, inflation, and public works. But if we are dumb enough to force-feed credit into the economy, let's not hide that behind a bunch of puppet banks. And let's keep it very clear that we are not confiscating private firms in order to make them tools of the state. We nationalize reluctantly, when we have had no choice but to inject public money (or guarantee assets, which amounts to the same thing) in banks that otherwise would have failed. We nationalize because, in a capitalist economy, investors get to keep the profits they endow, even when the investors happen to be taxpayers.

Some nationalization links

Update History:
  • 20-Jan-2009, 7:00 p.m. EST: Eliminated an artless overuse of "guaranteeing" by changing to "ensuring".
Steve Randy Waldman — Tuesday January 20, 2009 at 12:16pm permalink
Steve - Do you happen to know if under current law (without additional legislation) whether in a full nationalization of a bank *all* of its obligations become those of the government?

Aside from bondholder haircuts, what do you think could and should be done about the various exotic instruments and contracts on the books?
1.20.2009 2:32pm
Yancey Ward (mail):
BSG asks a question I have asked, too, and gotten no real answers. If I, a private citizen, purchased the outstanding shares of Citigroup, I would become the proud owner of the assets and the liabilities, but, I think, I am not on the hook if I choose to default to any more extent than the value of the shares I purchased. If another bank absorbed Citigroup, it is my understanding that Citigroup is no more, and the assets and the liabilities become the property and debts of the absorbing bank, and it the net worth of the new bank in it's totality that is the one responsible for Citigroup debts and contracts.

What happens when the Fed or the Treasury take over a bank without a declared failure?
1.20.2009 3:10pm
Yancey Ward (mail):
Also, a partial nationalization without a winding down might not work. Can you imagine how hard it is going to be for unnationalized banks to compete with banks nationalized and with a lot of their liabilities written down or absorbed by Treasury? Nationalized some, and you are likely to weaken everyone else in the process.
1.20.2009 3:13pm
JIMB (mail):
I think you've really hit it here "Better yet we should decouple the payment system from risk investment by reorganizing banking functions into "narrow banks" and credibly not-guaranteed investment vehicles."

In my view, the payment system should be non-debt, hard asset (gold or whatever else the market decides) with 100% reserves at all times. There's no telling how badly the gov will mess it up in the future ...

If we nationalize, let's bar any of the directors, managers, and finance people from receiving any income by managing or performing labor in the area of finance for 10 years.
1.20.2009 3:17pm
RueTheDay (mail):
Steve - Great post. Couple of points:

1. If the goal is to "decouple the payments system", and I think a very strong argument can be made in favor of doing that, then why "narrow banking"? Why not just go with full reserve banks, which would not be banks in the traditional sense, but rather would simply be transaction clearinghouses. They would pay no interest on deposits, but rather would charge depositors a small fee for storing their money and processing transactions. No need to have them "invest in Treasuries" (which IMO is an oxymoron if there ever were one).

2. Agree on the haircuts or debt to equity conversions for bondholders, but don't see any reason why we shouldn't have the courage to do it. People who bought bank bonds received a higher yield than those that bought Treasuries in exchange for taking on greater risk. Having the FDIC provide ex post guarantees of those bonds is silliness. On a related note, while I understand why the decision was made to backstop money market funds, it seems to me that the correct approach now is to take those shadow banks out of the shadows and regulate them as banks.
1.20.2009 3:46pm
Hello Steve and others,

What is the likelyhood that nationalization by any significant country, and the UK seems to be close, will trigger a tsunami of CDS-settlements, wiping out, internationally, not only the remaining big banks, but also most hedge funds and insurance companies?

If this is the case, nationalization could only be done internationally, with all governments doing it at the same time. A worldwide bank holiday...

Thanks for your blog, it provides great insight
1.20.2009 4:58pm
Benign Brodwicz (mail):
I think it's as simple as the problem of moral hazard. The big pigs knew they were "too big to fail," so they engorged themselves at the trough knowing the government would refill it.

The government should have guaranteed all deposits on day one of the crisis. How hard would that have been? How could that be inflationary? People would not have lost confidence in a single bank. And then they should have let banks fail and transferred accounts, deposits and assets. The payments system was never in jeopardy. The bums would have been thrown out, instead of keeping their jobs and making other people lose theirs. From everything I've read they did nationalization much better in the 1930s.

And if the whole kinky fractional reserve banking system is "insolvent," can't you just lower reserve requirements to fix that problem [after slaughtering the pigs]? Too much fear-mongering, Nouriel.

What matters is that people have confidence and money flows....

The problem is the plutocracy. The moneyed elite change the rules when it benefits them, and the rest of us are left cleaning up their mess. Hank Paulson. Let's try a TARP II.... It's amazing how hard it is to think clearly in a panic.

Pretty soon it's going to be time to start throwing the [Democratic and Republican] bums out of Congress who put this on our tab. Question is whether Pres. Obama will be able to mobilize us all to take the wind out of the plutocracy's sails, by voting bought-and-paid-for politicians out of office. It will have to be grass-roots, just like his campaign. Who would have thought that would ever succeed? Still, it's long odds.
1.20.2009 5:01pm
from the ny times:

"If policy makers were even remotely honest, analysts said, they would force banks to take huge write-downs and insist on a high price in return for taking bailout money. For practical purposes, that could mean nationalization or partial nationalization for many banks.

...William Seidman, a former chairman of the Federal Deposit Insurance Corporation who was closely involved with the bailout of savings-and-loan institutions in the 1990s, said the government should simply take control of the banks it tries to rescue. “When we did things like this, we took the banks over,” Mr. Seidman. 'This is a huge, undeserved gift to the present shareholders.'"



my guess (wishful thinking?): the above is part of a p.r. effort by obama's team, to inoculate people re: claims by special interests that nationalization is problematic.

reflecting, of course, obama's determination to preserve his chance at a historic presidency by forgoing any bailouts of insolvent banks...

after all, if the economy craters, foreign creditors force up interest rates, etc., voters would crucify obama for bailing out bankers 'tarp 1'-style...

great time to be a truly savvy lender, or to have a blueprint for becoming one...

place your bets! :-)

(great blog, steve. keep up the good thinking :-))
1.21.2009 12:18am
Lasse Enersen (www):
In Finland we had a great ole' bank crisis in the early 1990's. Very similar to what happened in Sweden and Norway around the same time. And also what is happening now in USA. Our government nationalized the so called "bad parts" which were non-functioning, and let the performing parts stay in private hands. This way the Finnish public never made any money from the nationalization. The bankers who got to keep the good parts, are now among the richest people in Finland.

I'm definitelly in favor of nationalization. Just for the citizens' sake.
1.21.2009 12:43pm
Massimo GIANNINI (mail) (www):
Read the 10 Planks of The Communist Manifesto written by Karl Marx in 1848

Plank N° 5. Centralization of credit in the hands of the state, by means of a national bank with State capital and an exclusive monopoly.

Perhaps we can discuss centralization and exclusive monopoly levels. Yet, either Marx was eventually right about the end of capitalism and linked ideas or United States of America is practicing plain Communism or Marxism.
1.22.2009 6:21am
great post!

unfortunately the opposite of what you propose will happen.

politicians still think that the banks simply aren´t making loans to creditworthy people.

the relaxing of lending standrads/forclosure moratorium at frannie gives you taste of what is about to happen.

since it´s not their own but "only" taxpayer money at risk i see no chance that politicians will behave responsibly. itstead they will listen to economist and try to force more credit down our throats.

RBS Will Be First Guinea Pig for ‘Creeping Nationalization'

By Jon Menon and Andrew MacAskill

Jan. 20 (Bloomberg) — Royal Bank of Scotland Group Plc, facing the biggest loss in British history, promised to make 6 billion pounds ($8.7 billion) available to U.K. borrowers as the government took another step toward full control.

In exchange for government guarantees on losses from toxic debt, the bank will have to sign a binding agreement with the Treasury on how much it will lend and on what terms. Auditors will move in to check the bank is following the government directive.


Banks wishing to participate in the U.K. government's 100 billion-pound bailout, the second in three months, must agree to “have specific and quantified lending commitments that will be binding and externally audited,” according to the Treasury.


RBS pledged to raise lending by at least 6 billion pounds to British companies after the government agreed to swap its preference shares for ordinary stock...

i agree with this quote:

“There is a possibility that this will help, but it will not solve all the banks' problems across the board,” said Tom Kirchmaier, a fellow at the London School of Economics. “For that you need consumers who are creditworthy and I am not sure that they are out there.”

thanks for your great work. nice to see that your posting frequency picked up lately.

greetings from Germany!
1.22.2009 11:56am
pochemukers (mail) (www):
Hi, friends!
Thank you for this forum. I have underlied a lot of useful infomation for me.
I have a question: can i ssppaamm in this topic ny sites to ads they?
Sorry, if I made the mistake, when asked this question.
1.28.2009 9:43pm
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