Nationalization and Reprivatization: Is a New Consensus Emerging?
The prevailing consensus on any economic policy is a fascinating beast. For years it can stay put, seemingly immovable, and even in some cases become enshrined in legislation or central bank statutes. One day it begins to shake ever so slightly; under the pressure of events a wider range of serious opinion develops. And then, all of a sudden, the consensus breaks and you are running hard to keep up.
We saw this last year with regard to discretionary fiscal policy—fiscal stimulus—in the United States. Eighteen months ago, very few mainstream economists or other policy analysts would have suggested that the United States should respond to the threat of recession with a large spending increase/tax cut. The consensus, based on long years of experience and research, was that discretionary fiscal policy generates as many problems as it solves. To argue against this consensus was to bang your head against a brick wall, while also being regarded as not completely serious.
At some point in November/December 2007, this consensus began to shake. The history may prove controversial, but my perspective at the time and in retrospect is that Marty Feldstein was the first heavyweight economist to question the consensus (including in interactions on Capitol Hill), and he was followed closely by Larry Summers' influential writings in the Financial Times. Within a month or so, the consensus had broken. Not only did we get a fiscal stimulus in early 2008 for the United States, but the International Monetary Fund (IMF) quickly adopted the same prostimulus line globally and the terms of the debate changed everywhere. This fed into a process out of which came at least a temporary new quasi-consensus: A large US fiscal stimulus is part of the sensible policy mix today.
The consensus on banking just broke cover. For some weeks it has been under intense pressure. At least since the fall, serious people have been informally floating various new ideas on how to deal with the technical problems surrounding toxic assets and presumed deficient bank capital. But since mid-January, the mainstream consensus—that we should protect existing large banks and keep them in business essentially "as is"—seems to have cracked.
Paul Romer and Willem Buiter favor an approach that emphasizes the creation of new banks. Roger Farmer wants to go in a completely different direction. These are just a few examples of the great (and completely constructive) new dispersion of ideas around banking.
Advocates for the previous consensus—and the status quo—seem to be located mostly in the financial sector itself (e.g., Lloyd Blankfein). The administration's view, as I discussed with Bill Moyers last week, is apparently still up for grabs. And I understand "what's next" for banks will be a central theme for debate among staffers on Capitol Hill this week.
On the technical details, I could support any number of schemes. My main concern is limiting taxpayer downside and making sure the taxpayer gets as much upside participation as possible. We have a proposal on the table, but other ideas have merit and the US debate in this regard seems likely to be productive, in striking contrast with Europe, where denial is still the name of the game.
There is only one point on which I would insist. The banking lobby has become too powerful, in large part because big banks have balance sheets that are too big relative to the size of the economy. If a bank has total assets of over 10 percent of GDP, it is obviously too big to fail. Of course, the smart people who run these banks know this and act, politically and economically, accordingly.
We need a strong system of financial intermediation, and this must feature people willing to take risks with their own capital. In that context, there may be efficiency arguments in favor of relatively large deposit-taking/lending banks (although I'm far from convinced), but it is the political-economy considerations that are overwhelming. When all is said and done, if we still have large banks with great political power, we will eventually find ourselves in even bigger trouble.
A Further Note on Nationalization of Banks
The worst possible way to nationalize would be to assume responsibility for the liabilities of banks, while simultaneously not putting in place adequate oversight and failing to ensure that the taxpayer gets any upside. Even worse, we could install managers with a proven track record of incompetence. Anyone who proposed such a scheme today, as we collectively kick the tires of plausible alternative approaches, would be dismissed as a ridiculous crank.
Yet it is exactly this kind of nationalization that we, or, more specifically, Hank Paulson, already did.
It is true that there has been no change of control and that bank shareholders have done remarkably well under the circumstances. And it is also true that the amount of new capital, from the original TARP funds, is relatively small for most banks (Citi and Bank of America are the exceptions). But, make no mistake about it, the Federal Reserve and the Treasury, acting on behalf of taxpayers, saved the banking system in late September/early October 2008 through making available large and extraordinary lines of credit, as well as key injections of capital.
Of course, this was not formal nationalization, but it placed us on the hook for most, if not all, of these banks' liabilities. In effect, we provided a massive, cheap insurance policy to the banks, the people who run them, and their boards of directors. Focus on these boards for a moment; they are very much part of the problem.
Corporate boards are supposed to represent shareholders, but to a large degree they do not. Most board members are appointed by the CEO or hold their position due to the CEO's tacit support. The idea that these board members effectively oversee the activities of these large banks seems almost quaint. While I am sure they are all fine, upstanding citizens, many of them seem considerably out of their depth. Others seem too deeply intertwined with the company executives, with other boards, and with the corporate elite more broadly. Strikingly few of them have stepped forward to take any kind of responsibility.
Fannie Mae and Freddie Mac were "taken over" by the government—placed into conservatorship—in the summer of 2008 because the Treasury determined that they did not have enough capital, so there was a risk they might need to draw on the government. Both boards of directors were removed at the direct instigation of Secretary Paulson. He had the legal right to do so precisely because these institutions had special access to the public purse. Note, however, that Fannie and Freddie had not actually drawn on the Treasury at the time they were taken over. It was the view that since there was a prospect of them drawing on the Treasury, the secretary was entitled to act.
Since then, of course, all banks have received similar access, through TARP and the Federal Reserve, to be topped up by further support announced last week by Secretary Geithner. Some might still argue that accessing liquidity from the Federal Reserve is not the same thing as the Fannie/Freddie arrangement, as the Fed supposedly never takes credit risk. But this is not a widely held position, particularly after the second round of bailouts for Citi and BoA. And Secretary Geithner, following in the footsteps of Secretary Paulson, clearly indicated that the Treasury would provide risk capital in all the schemes involving the Fed, i.e., the bookkeepers may quibble about the details, but you and I will be providing extraordinary financial support to the banking system for the foreseeable future.
Why did Secretary Paulson therefore not seek the legal authority to remove or change boards of directors when a bank drew, or could potentially draw, on the government? Presumably, he did not want to upset the banks' executives. Perhaps there were other reasons.
In any case, the issue today is not whether we should nationalize. Mr. Paulson effectively nationalized the liabilities of major banks without putting in place any effective supervision of banks' operations. This is not a winning combination.
What we really need is to reprivatize—to return the banks to real private owners, preferably with strong voices on boards, and perhaps with controlling ownership stakes. And we must, above all, make sure those owners have the incentive to break the banks into smaller, more manageable pieces, none of which are "too big to fail." As part of this process, some boards of directors will either have to go or be reshaped dramatically. And new boards can decide who should or should not run these greatly restructured banks.
Adapted from Simon Johnson's blog,