Wednesday, October 8, 2008

Should our banks be nationalized?

This article by a conservative editor (Wolfgang Munchau) of a conservative European newspaper (Financial Times) is worth a quick read.

Some excepts from the article:

The US administration’s TARP proposal is a case in point. It has lambasted by almost every economist, including those who normally disagree with each other on most things. Buying up toxic securities at above market prices is simultaneously the most expensive and unfairest way to recapitalize the banking system. It is very difficult to believe that the US treasury secretary can possibly be driven by a motive other than a wish to benefit the investment banks he once chaired, and which stands gain handsomely from such a package, and which would never dream of accepting any government capital infusions. The only alternative explanation for his behavior is immense stupidity – and I know that he is not a stupid man.

We have learned from those mistakes, but are committing new and possibly bigger ones. Government is our one and only safety net. It could, if it wanted to, provide basic financial services, that could easily fulfill three economic functions that are attributed to finance: to provide liquidity, to share risk, and to allow agents in the economy to make inter-temporal choices. .... The way to go is to shrink the financial system and nationalize the systemically important financial institutions. I have heard there are about 45-50 in the euro area though this is not a precise guess, and subject to change over time. After the financial sector is stabilized, it is time to rebuilt the system, to allow the government later re-privatize its assets, ideally subject to different incentive structures than those that have led to this crisis. In theory, governments could even make money on it. I doubt it. But at the very least, governments can minimize losses.

But if you squander valuable resources on second-rate institutions such as Hypo Real Estate, for the wrong reasons, your freedom of maneuver will be constrained at the moment you need it the most, ...

These three quotes highlight what is wrong with our government's response to date and propose what a better solution would look like. The first points out the TARP program can only be pursued for personal greed and not to address the problem. The second states that nationalizing the financial system is possible and could address the problem. And the third points out that if we waste all our resources buying worthless paper, whether they are toxic assets from banks or unsecured commercial paper, we will lack the resources to effectively deal with a full scale collapse of our economy. For instance, the FDIC protects our deposits by assisting large banks in buying failing smaller banks. What do they do if our largest bank, Bank of America, begins to fail?

Nationalizing the banks while we still can may be our best option. But I have not heard any of our politicians talking about this. We need to make them aware that this is an option and they need to consider it.

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