On Nationalization
Lawrence A. Hunter, Ph.D.
March 9, 2009
If Starbucks went into bankruptcy would we say it had been "nationalized?" No, we wouldn't; we would say it went bankrupt. Would we find the bankruptcy proceedings an unwarranted government intervention? Only the purest of pure anarchists would.
The company either would be restructured/reorganized and re-launched or it would be liquidated, its assets sold and its creditors paid off to the extent the proceeds of the asset sales allowed -- that is, unless the government intervened and it really was nationalized with government injections of capital, government guarantees and so forth that put significant public tax money into the firm and resulted in significant government control of the company. But as between the two situations there would be a clear distinction that everyone could agree upon even if they disagreed on the advisability of the latter course of action.
Why then do so many people call it "nationalization" when it is proposed that the FDIC or some special new entity created to handle the current mess take over an insolvent bank to do essentially what a bankruptcy judge does for any non-financial institution? Probably because it is policy and law in the United States never to allow a bank to ever actually fail. Hence, to free-market folks, FDIC intervention and seizure seems somehow usurping the market. Whenever the FDIC takes over a bank and seizes its assets, it is by definition "preemptive" action occurring before the institution actually fails, which could be described as "nationalization." Presumably though, the FDIC only takes such extraordinary action when the institution would fail were it not seized—a judgment call admittedly, and one subject to error and abuse but for purposes of this discussion it is convenient to categorize any institution closed by the FDIC as being in imminent danger of failing—which would fail if the FDIC did not intervene.
This is not what one ordinarily thinks of as "nationalization." Indeed, bankruptcy proceedings is a form of government "intervention" most free-market folks agree is necessary as essentially an adjudicative function of government. Moreover, such intervention is not premised on market failure but on enterprise failure, which is part and parcel of the free enterprise system.
So, the best I can figure it, the reason so many free market folks resist an FDIC-like closure of the big, bad banks (beyond those who fear "systemic risk," which I believe is an unwarranted night terror) is not because they object to bankruptcy or even because they object to the special albeit flawed FDIC version of "bankruptcy" but rather because current law does not allow banks to proceed through the normal free-market process of economic-failure-first-then-bankruptcy. Since there is indeed the possibility of mischief and/or error anytime a government agency wields preemptive powers to do anything before the fact in anticipation of the unfolding of events, I sympathize and agree with people's reluctance to support the current (FDIC) approach as a good idea as a general proposition. In other words, I agree there must be a better way to handle bank failures, like first allowing them to fail. But again, the current arrangement is the imperfect result of earlier interventions, i.e., deposit insurance, that gives the feds a direct stake in this process, and of course taxpayers/voters are going to insist on something they think will be a "least-cost"/"least-disruption" approach, e.g., preemption. We are living with the chaos of earlier interventions, lamentable but current reality.
It appears to me that what free-market folks are really objecting to is the currently normal and ordinary manner in which bank closings are handled in this country. The conversation, it turns out, is really about changing long-time policy, not a debate over how to handle the current crisis—unless, that is, one insists that the entire system must first be overhauled before the big, bad banks can be dealt with. That seems impractical to me but certainly it is a justifiable position to hold. The question one must grapple with is, is this crisis the time and the place to hold the country hostage to fundamental policy change? Some would argue that a crisis is the ONLY time to hold the politicians accountable and force change. I must say I find that hypothesis appealing but risky and frankly not really politically practical. We are much more likely to end up with the crazies running Washington giving us a worse result if we reject the existing normal order or refuse to accept only relatively small incremental changes to it right now. Tough call.
If you hold the position that now is the only time to force change though, please be forthright in stating your premises and making your case. It is not helpful, in my opinion, to confuse this principled objection to the existing process with a claim that applying the normal and ordinary process to big, bad banks is unacceptable because it constitutes "nationalization," which conjures up images of the government seizing entire industries to operate. Then the debate degenerates into a food fight over abstractions.
This is a long-winded way of saying, yes I prefer changes to the FDIC process. In fact, the best thing we could do is eliminate deposit insurance and pension fund insurance and allow banks to fail. Unfortunately, this is not a politically viable option to hold out for in today's political environment. But short of that, there may be incremental changes that could be implemented as part of the extraordinary process of cleaning up the big, bad banks.
For example, anytime the FDIC ends up concocting a workout for which it can't find a willing buyer (as happened with IndyMac) and then ends up having to run the institution for an extended period of time, it has by definition failed in devising a viable workout. That should be unacceptable. However, we should acknowledge that the "nationalization" of the bank that results from a failed FDIC workout is the consequence of the FDIC's failure but not its original intention going in. In cases like IndyMac, the public would have been better served had the FDIC liquidated the bank, sold off the assets piecemeal for whatever the market would bear, paid off creditors to the extent it could out of the proceeds of the asset sale and been done with it. Goodbye IndyMac.
Moreover, the current back-room deals and negotiations undertaken by the FDIC would benefit from transparency and more use of market offerings to compel the most efficient outcomes. Hence, it might make sense for Congress to provide for special handling of the big, bad banks by the FDIC to rectify and minimize these types of problems which will only be magnified with huge bank closures.
However, it is my belief that the vast majority of the politically viable alternatives to the current FDIC process are so ill-conceived and fraught with danger (can you say Geithner/Summers/Bernanke?) that simply employing the FDIC process warts and all would be far preferable to letting the crazies in charge of the government create something new.
Our benchmark should be, I believe, a list of dos and don'ts against which to measure any proposed solution. I have specified my preferred list before, and I am sure it isn't perfect but here it is again:
First, no federal funds should be used to "recapitalize" any existing banks or to capitalize any new banks. New capital, to the extent it is required, should be raised in public stock offerings or through injections of private capital by acquiring banks in a carefully negotiated deal done in full public view.
Second, the only way federal funds should be used is to make good on promises/guarantees the federal government already has made, i.e., deposit insurance, pension funds, legal promises to creditors in earlier rounds (ill-advised though they probably were) and so forth. Something should be done to limit government's exposure this time around on money market funds which it guaranteed outside the law in the middle of the panic in the recent past. Absolutely no speculative "purchase" of any assets or institutions by the federal government in search of "cleaning them up and running them for a while and then 'selling' them at a profit." This would be a prescription for disaster.
Third, no effort should be made to "save," or "re-tread" any bank that fails Geithner's "stress test" through forbearance schemes. They fail the test, they close their doors; go into conservatorship; get liquidated or merged and toxic assets cleaned up and sold off ASAP --
Fourth, make sure any mergers and/or acquisitions forced by the FDIC are done in the light of day at market prices -- no backroom deals -- and that any debt/equity swaps give the banks' creditors an appropriate haircut. Also, NO FEDERAL GUARANTEES should be given AT ALL, PERIOD. If there is not a ready buyer for the cleaned-up core of the old bank at market prices, it is not clean enough. No formulaic pricing of whole banks either. All sales/acquisitions/mergers must occur in the light of day, preferably at public auction. Here the toxic assets could pose a problem unless they are removed from consideration of any merger and handled properly in one or more RTC-like facilities. Again, no federal guarantees on toxic assets should be allowed. No formulaic prices should be put on those assets either. They should be brought to market in an orderly manner only after they are properly cleaned up for public sale. If an asset(s) cannot be cleaned up/re-worked and sold at a price determined by the market, that asset should be considered a rotten apple, worthless, and discarded.
Fifth, find a way to limit the federal bureaucracy's operational participation in this effort and do not allow federal bureaucrats to run the banks or establish operating rules and criteria from the outside—no more IndyMacs. Make sure that banks failing the stress test are kept in operation under conservatorship as short a time as possible and that it be a TRUE conservatorship, not a bureaucratically run bank. This will mean outsourcing this function preferably with a judge not a bureaucrat overseeing the process.
Sixth, make sure there is no in-between status for banks. Either they pass the test and receive NO federal funds or intervention or they fail the test, in which case they are closed down entirely through a process that satisfies the criteria above.
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