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.

39 thoughts on “What to do with nationalised banks ?

  1. How to run nationalised banks?

    Short term: Run them according to existig laws and regulations. This provides a test of the existing laws and regulations and the underlying advice. This sounds tongue-in-cheek. But it is not meant to be. For quite a long time an awkward little question has been bothering my simple mind regarding the policy program of ‘privatise and regulate’. The question is: How can people of great integrity regulate (or manage) something which they don’t know what it is operationally? Alternatively, if they do have the knowledge then this implies a duplication of the acquisition and application of managerial knowledge, which does not seem to me to be cost effective.

    The above proposal provides an opportunity for law makers and regulators to find out – first hand – why the system doesn’t work.

    One hypothesis. The growth in the types of financial contracts during the past 20 years or more has been lawful. Banks and financial institutions are required by law to report via balance sheets. My hypothesis is that the law makers and regulators will find out – by running the banks themselves – that they can’t report all legally allowed financial contractual relationships in balance sheets. This leaves two policy options: Make all financial contracts (those written in currency units) illegal which do not fit into the balance sheet or develop an informtion system which allows the logical coexistence of the regulations.

    Furthermore, this experiment may give us all a better understanding of where the boundaries should be between private and public for the foreseeable future, given our current technology.

    Long term: If other policy objectives (eg sustainability, both ecological and social) aren’t to be forgotten, then it seems to me that we may have to look somewhere other than macro-economics. By macro-economics I mean the 19th century belief that ‘free markets’ are self-regulatory and Walras Law translates into the gold-standard; Keynesian economics as interpreted by Hicks, and Friedman and v. Hayek’s reinterpretation of the 19th century aggregate model. Centralised resource allocation has been tried and rejected. This leaves theoretical models which take into account finite natural resources (finite live of the earth), individuals, characterised by preferences and endowments and technological knowledge and a lot of interesting work, hopefully jointly with scientists.

  2. #25 Daggett, I was a little bit sloppy. I didn’t mean to say growth would continue indefinitely. I meant to say “As long as returns on investment are positive (roughly, as long as growth continues), interest rates will remain positive”

    Conversely, as the classical economists worked out, in a stationary state, interest rates will be equal to zero.

    As an aside, I’ve read a fair bit of JKG and never seen any statement like this. I don’t know about Woodrow Wilson, but I don’t see any reason to treat him as an authority on economics.

  3. Professor Quiggin,

    As shown in “Money as debt”, Woodrow Wilson stated words to the effect of that by having given banks too much power he had largely destroyed the future of his country.

    JKG said that the process by which banks created money was deceptively simple.

    I argue, and “Money as debt” argues, if it is so simple, why shouldn’t democratic governments, which are accountable to the people, take that power out of the hands of private banks and assume it for themselves?

    Surely we would have avoided the current financial calamity and many past financial calamities if that had been done?

    I am relieved to learn that you do agree, after all, that the planet is finite.

    Would you accept, given the parlous state of the world ecology, that we have already passed the point where further economic growth can be sustained?

    Surely, we need to change from a growth-based economy to a steady-state economy and, at that, one based upon considerably less consumption of natural resources than is now the case?

  4. daggett – I am not so sanguine re governments as if secrecy provisions are similar to today then similar problems will arise. That is, the people who control the flow of capital will make sure it flows to them. We need very open systems.

    re the steady state economy. Where do we set the steady state? It is possible there are too many people at the moment to set the economy/consumption at a comfortable level. We may need to find a way to reduce population. However creative and humane approaches to encouraging population decline are needed – I am not in favour of anything which penalises or stigmatises people for having lots of children. Perhaps changes which make having lots of children less desirable are possible eg taxation on house size, car size and so forth. There must be people with expertise in constructing population policy.
    On the other hand – there is so much junk produced and so much effort spent on stimulating demand for that junk that perhaps there is ample room to reduce consumption significantly whilst having high quality of life with the current population.

  5. Re #16. In reply to the question: “Can anybody tell me what the flaw in the video Money as Debt is?”

    There may be many flaws beside those which I can see:
    1. The history of the evolution of money and banking is strange in parts. It seems to me too much credit is given to the Europeans for the creation of banking and the story of the gold smith is surely an oversimplification. (Who is the intended audience?)
    2. The history about fractional reserve bank lending is certainly not new. I was taught this system during my undergraduate years – many years ago but I won’t tell you how many.
    3. The history is incomplete. It ignores the recent evolution of financial instruments by private corporations and individuals. This is an opportunity to bring in the inventiveness of the US.
    4. The idea that money is debt is not new either. For example, the video fails to acknowledge the thesis by Andreas Furche (2001), Macquarie University, which provides a uniform description of monetary objcts, their creation, circulation and destruction and the concept of all instances of money in this work makes the debt obligations on the issuer quite clear.
    5. The promotion of the idea of switching to zero interest and having only one issuer of debt, the government, seems to neatly coincide with what is happening in the U.S.
    (Point 5 is not a flaw but rather an observation only.)

  6. Roosevelts thesis concerning the relations between government ang big business may just come in handy at this time

    a) the existence of big business must be contingent on the proposition, that like government, it is a servant of the people.
    b) A corporations activities must be guided not on how much can be safely charged for services, but on how much can be given the people in return for as small a profit as will ensure good wages and welfare of workers and a moderate return on the investment.

    c) since capital is moral only when it is put to work for the common good, the piling up of huge fortunes as an end in itself is immoral and against the public interest.

    d) legislation should spring from the will of the people and not from the lobbies of special interest. Wherever privilege exists in legislation it should be placed under rigit public control.

    e) A franchise to exploit public resources, whether oil, water power or forest reserves, is a public trust, awarded to private interests under the definite stipulation that waste of resources must never happen, and the public never be charged more than a fair price for the development of what, after all, belongs to them.

    f) in any case of conflict between public and private interest, the latter must yield. If it will not do so of its own volition, it muct be persuaded to do so by legislative or executive actions.

    We seem to have, in the rush to de-regulate everything, acted contrary to every single one of these wise suggestions. I would say they apply very much to any relations between government and the nationalised banks and if they are not happy about it, let them all fail.

  7. f) in any case of conflict between public and private interest, the latter must yield.
    If it will not do so of its own volition, it must be persuaded to do so by legislative or executive actions.

    woooohahahaha, oh dear, i think i peed my pants

    it just brings me back again to the recurring nightmare i have, brought about by the orwell essay involving the sophistication of weapon systems and the relative power of the people in class wars,

    we, my friends, are in deep shit

  8. I cannnot alas Daggett. I am quoting direct from a very yellowed hardback book (page 86) published in 1942 by Peter Davies Press, London, called “Roosevelt – World Statesman” by Basil Woon which I found in second hand bookshop. I like collecting any old interesting ones but this happens is the the oldest.
    It has a hand written inscription inside “from Marcus R Barlow, Camberwell” “from Tall Timbers, Xmas 1944”

    Well Ill go off on a sidetrack because this gets interesting – Marcus Barlow was an reasonably well known Melbourne arhitect and I found this on the web

    The sparkling new straw houses, built in a strip along Maidstone St, Altona, were designed by one of Melbourne’s leading architects, Marcus Barlow. It is a mystery to me why a ‘society’ architect like Barlow, who was educated at Brighton Grammar School and lived in a mansion in Camberwell, concerned himself with straw workers’ cottages in outlying Altona. Barlow designed notable city buildings like the famous Manchester Unity Building on the corner of Swanston and Collins St, Melbourne, the Edments Building in Adelaide, the Victorian Insurance Building in Perth, and many other noteworthy structures.

    Anyway – I like Marcus R Barlows taste in books.

  9. Alanna,

    Nevertheless, thanks. Thanks, to you an electronic copy of those particular very sensible ideas of Roosevelt’s now exists.

    There are some references to Bail Woon’s book on the web including “A drink’s French connection”.

    Sounds like Marcus Barlow had a lot going for him in being willing to apply himself to what would have been considered by many as the less prestigious concerns of providing workers’ dwellings.

    Ernestine Gross, thanks for your response.

    It seems to me that some of the omissions you mention would be justified in the interests of brevity.

    There is a lot in there to get my head around. For example, how is it that the Bush regime, utterly devoted to serving a corrupt sociopathic ruling elite at the expense of ordinary Americans and the rest of the world would adopt measures that, on the face of it, appear to be socialist?

    Whatever the reason might have been, it could not have been to willingly serve the common good.


    Your post raises a lot of issues which cross my mind constantly. In fact, I think we have passed the point where we not only should we be applying moral pressure to limit the size of families, but we should also begin to contemplate more coercive means to limit the size of families, at least beginning with financial disincentives as you have suggested.

    Your point about the creation of needless demand is a good one and yet another illustration of the utter irrationality of our ‘free market’ capitalist system. Have you read Sharon Beder‘s “Consumerism – an Historical Perspective”?

    It shows how in the 1920’s at a point when rising workers’ productivity would have made it possible to reduce the working week, the US ruling elites, instead colluded behind the back of the people to convince workers, through extensive propaganda campaigns, to buy more goods and to continue working longer hours. This, of course, has continued right up to this day. This makes complete nonsense of any suggestion that a desire to excessively consume the earth’s natural resources was natural on the part of ordinary people.

    However, we have reached the point where simply removing that artificial additional demand may not be sufficient to solve our problems, but it would certainly be a good start.

    We can only hope to solve the problem by first stabilising our population and then by allowing it to decline naturally, before the limits of our natural world do it for us.

    Anyone who holds that we can afford to be, in any way, complacent in the face of the peril of human overpopulation is dangerous and reckless, even more so those who actively seek to increase the population of the world or any country within it.

  10. Well Dagget – there were 3 more points listed under Roosevelts thesis concerning the relations of government and business.

    f) In general, private ownership of utilities should be discouraged in favour of public ownership. In some cases private ownership may be publicly financed, in order to prevent undercover control of utilities by men who have none but a purely financial interest in them.

    h) Money does not of itself entitle its owner to any legislative privilege. But if the money can be shown to be working for the good of all, then its possessor may be rewarded by privilege. But all privilege is and must be a prerogative of the people. (italics emphasis on last sentence)

    i) The transactions of all public companies must always be open to inspection and, if necessary, approval of the public, through their appointed representatives.

    And in a message to Congress in April, 1938, asking for a revision of the Sherman anti-Trust law, the President wrote that the aim of measures he proposed was “to preserve private enterprise for profit by keeping it free enough to utilise all of its resources of labour and capital’ then he added “The concentration of power in private hands today is without equal in history. The one lesson in events abroad…is that the liberty of a democracy is not safe if the people tolerate the growth of private power to a point where it becomes stronger than the democratic state itself. That, in essence is Fascism.”

    I think we have equalled it some 70 years later.

  11. Pr Q says:

    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.

    We “reasonable commentators” can all agree that bank nationalisation is the sensible policy option. Unfortunately politics, understood as the distribution of spoil, usually trumps policy until all other survivable alternatives are exhausted.

    The simplest reason why Obama will not nationalise the zombie banks boils down to money. Not the Treasury’s money, theres trillions of dollars they can pixal up at the drop of a keypad.

    I mean the money at stake for owners of the Wall Street banks and officials of the Democratic Party.

    Over the past half decade or so the DEMS have been the biggest recipients of political donations from Wall Street. The LA Times reports on the big turnaround in Wall St political sympathies:

    Hillary Rodham Clinton and Barack Obama, who are running for president as economic populists, are benefiting handsomely from Wall Street donations, easily surpassing Republican John McCain in campaign contributions from the troubled financial services sector.

    It is part of a broader fundraising shift toward Democrats, compared to past campaigns when Republicans were the favorites of Wall Street.

    For now, though, Sen. Clinton of New York is leading the way, bringing in at least $6.29 million from the securities and investment industry, compared with $6.03 million for Sen. Obama of Illinois and $2.59 million for McCain, according to the Center for Responsive Politics.

    Those figures include donations from the investment companies’ employees and political action committees.

    ANd of course Wall St donating to the DEMs does not imply that the MoUs have had a sudden Left-wing change of heart. Rather it implies that the DEMs are available to the highest bidder, of rather Right-wing persuation.

    Maybe that explains why Obama chose Larry Summers, the economist most identified with financial market liberalisation over the past generation, to master-mind the bail out plan.

    When you think about it Wall St donating to the DEMs makes a lot of sense. After all the REPs will do Wall Streets bidding for free. So if you have a political donation budget it is most effective to give it to your natural enemies, to hedge your bets. That sort of logic would appeal to traders.

    In return for political donations the Wall St banks get to keep private ownership of the banks and their bonuses. So when the stock market recovers they reap a massive capital gain and resume business as usual.

    Whats not to like about that deal?

    Nothing except it does take some of the gloss off Changey-Hopey Obama. Like I said from the get-go, that dude plays a mean Cool Hand.

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