Bank Nationalization Is a Truly Awful Idea
In the past week a number of boldfaced names including Sen. Lindsey Graham, Harvard economist Greg Mankiw, economist of the moment Nouriel Roubini, and ex-Fed Chairman Alan Greenspan have suggested that the surest path out of our government-driven financial crisis is for that same government to take over some of our struggling banks. This isn’t The Twilight Zone - that show was cancelled years ago - but this is the growing consensus among some of the best known economic thinkers here and around the world.
On its very face, nationalization is a truly awful idea. We’re regularly told that the collapse of major banks is the major risk to our economic health, but it’s more realistic to say that the greater risk involves government control of those same institutions. Be it a bank or any kind of business, when their owners aren’t motivated by profits, and that describes the federal government perfectly, they no longer face the exacting discipline of investors who demand market returns.
Worse when it comes to banks, once under government control they either are forced to invest conservatively, in politicized ways, or in the case of the alleged beneficiaries of TARP funds, they’re required to engage in the very non-economic lending that made them insolvent to begin with. Institutions that have failed their investors, whether it be GM or Citigroup, should be allowed to fail so that they no longer waste human and financial capital that could otherwise be deployed profitably.
Of course some, including Greenspan and Roubini, argue that nationalization would be a clean process that would lead to a quick resale of these institutions by the government back to the private sector. It’s a nice thought, but judging by the slow and difficult de-nationalization of British firms that Nigel Lawson (the U.K.’s Chancellor of the Exchequer under Margaret Thatcher) oversaw in the ‘80s, it’s positively naïve to assume that de-nationalization would be simple here.
And as MIT professor Lester Thurow has observed, “Disinvestment is what our economy does worst. Instead of adopting public policies to speed up the process of disinvestment, we act to slow it down with protection and subsidies for the inefficient.” And assuming an efficient process of disinvestment, it’s charitably utopian to presume that our federal minders would ever again allow banks to control their own lending destiny. Banks would join utilities and other prosaic wards of the state as politicized entities offering non-economic loans that would do nothing for our economic health.
Nationalization advocates, including Roubini, point to Sweden’s successful bank nationalizations and subsequent disinvestment as a model that could be applied here. Nothing against Sweden, but when we consider the size of its banking system relative to ours, the nationalization of its banks is the equivalent of government officials in West Virginia taking over financial institutions there. Harmful to the economy for sure, but not relevant to ours or the world economy in any material way.
The above is true given the basic truth that money, like finance, is fungible. Dollars, yen and euros are the same everywhere, so if officials in Sweden or West Virginia were to take over the banks, companies and businesses within both could still find rational, profit-driven finance outside of their state-run banking systems.
The United States, however, is quite different. Were we to nationalize our sick banks, some of which list among the largest in the world, we would very quickly harm our banking system in total. Indeed, with capitalism and the health of banks very much reliant on the efficient deployment of capital to its highest use, banks backed by owners not motivated by profit would quickly prove cancer-like to the many healthy banks in our system.
Competing for loan opportunities against institutions being told to lend as though free money is an economic stimulant, the strong would quickly weaken alongside their federal competitors. In short, the world’s center of finance would soon enough morph into a favor factory along the lines of the crony banking system that helped take down Indonesia’s economy in the late ‘90s.
The logical reply to all of this is that finance is once again fungible, and if nationalization makes our banks irrelevant, U.S. firms could still look overseas for profit-driven capital. This is all true in that just as there’s no logical explanation for why we need U.S.-based energy sources, there’s nothing saying we must have U.S.-based sources of finance.
The problem with this assumption is that given the size of our banking system, its takeover by the government would have worldwide consequences. Indeed, government aid or nationalization is merely protectionism by another name, and with our banks greatly distorting the lending process, it’s not a reach to assume that foreign banks, seeking protection from U.S. loan practices, would follow our lead. Simplified, crony banking practices stateside would quickly prove virus-like and help to corrode lending standards worldwide as governments sought to protect their own champion banks.
The better answer is to simply let markets run their natural course. As recently as the ‘80s we heard with deafening regularity that the size of Japanese banks relative to ours was a certain signal of our economic decline. While this later proved demonstrably untrue, it’s an historical fact that when these Japanese banking behemoths lurched into insolvency, market-oriented thinkers in the U.S. correctly prescribed failure for those institutions as the surest way for Japan to resume its impressive economic growth.
So if Japan’s largest banks in the world were not too big to fail, it seems fanciful to presume that bank failure here would consign us to poverty. But what will impoverish us is if bipartisan hysteria leads us toward a process of bank nationalization that is almost certain to spread, and weaken institutions of finance worldwide.
Going back to last year, the purely conjectural notion of “too big to fail” entered the economic discussion in such a way that our economy has continued to weaken. The better answer is that our banks are far too important to be saved by Washington, so rather than continue down the impoverishing path of federal aid, the true solution involves letting the weak die so that existing and future banks can handle the deployment of capital in ways that their previous competitors failed to.