What to do with nationalised banks ?
All reasonableTM commentators now agree that nationalisation of big banks like Citigroup, Bank of America and Royal Bank of Scotland must take place soon, explicitly or otherwise. As I said at just before the second (failed) Citigroup bailout) banks like Citi are not only too big to fail, they’re too big to rescue with any of the half-measures that have been tried so far.
It’s obvious that “If it were done when ’tis done, then ’twere well It were done quickly” and cleanly, without any dodges designed to hide the reality of nationalisation. The longer these zombie institutions are allowed to run on public money, but under the existing discredited managers, legally answerable to the private shareholders, the bigger the costs the public will ultimately face.
Nationalisation would resolve a lot of the difficult questions around ideas such as the creation of a “bad bank” to hold all the toxic assets accumulated during the boom. That’s critical as long as policy is aimed at turning the troubled banks around while keeping them private, but it’s unimportant once all the debts and assets have been taken on to the public balance sheet. Once the big banks are nationalized, the government can take its time salvaging whatever assets are still worthwhile and preparing for the reconstruction of a private banking system under a completely new system of regulation, a task that is likely to take several years.
The big question is, what should governments do with the banks once they own them? Clearly, there’s an imperative for banks to start lending again, but there is no benefit in making yet more bad loans. And, right at the moment, credit-worthy borrowers are hard to find. The immediate concern must be to ensure that commercially sound loans aren’t being constrained by the need to bolster bank balance sheets. Then, governments need to consider whether some form of support for loans, such as interest rate subsidies or guarantees (secured against assets seen as having a long-term value that exceeds their current market value) should be part of the policy response to the recession. Such policies have plenty of risk associated with them, but the risks are mitigated a bit if the guarantor and the bank owner are ultimately the same (in this case, the public).
Obviously, this is not the kind of question economists have spent a lot of time thinking about until fairly recently. I don’t imagine many of us would have expected, a year ago, to be reading the Wall Street Journal castigating Henry Paulson and the Bush Administration for the (partial) nationalisation of the Bank of America. No doubt plenty of mistakes will be made. But there is no time for leisurely reflection here. As in 1933, the next hundred days will make a big difference, one way or another.