Wed, 25 Feb 2009 21:04:36 +0000 – By Steven KyleProfessor, Applied Economics, Cornell University
Ideological labels (accurate though they might be) can get in the way of pragmatism. You would have to be at least 80-years-old -- or an economic historian -- to truly understand what another Great Depression would mean for our country. It's the possibility of another Depression, however, that has our policymakers and most economists so nervous. Letting our biggest banks fail would cause a chaos far worse than what we have experienced since Lehman went down last fall. Avoiding a major economic meltdown is, and should be, the top priority of everyone concerned.
So if reality is such that...
a) those mortgage related securities aren't worth much today and only will be worth something later if both the stimulus and the coming bank rescue plans are successful and...
b) We NEED the banks to survive for success...
...then there is no choice but to ensure that the banks are cleaned up and made viable commercial entities once more. But that leaves an open question of how to do it and who bears the cost.
By now it should be clear that it would be insane for any private sector individual or entity to want to buy the "toxic assets" that belong to many financial institutions. For better or worse that simply isn't on the menu. And it means only government can do it. Fortunately, our government has both the experienceto do it (it's taken over two banks a week so far this year plus, in terms of a large bank takeover, it handled the Continental Illinois episode back in the 1980s) and the incentive to make it work. -- This is probably the cheapest (and best) route we have to relaunching a viable banking system in this country.
First, if the government takes over Citigroup and Bank of America it can rapidly strip out the bad assets and resell the banks to the private sector. With newly clean balance sheets there will be no lack of buyers. Those "bad assets" left in the government's hands will increase in value if there is a healthy banking sector and if the stimulus is succeeds. In fact, a takeover could even result in a profit for the government if the eventual default rate on mortgages is kept anywhere even remotely near the current seven percent.
Second, we havealready put more money into these banks than the total value of their outstanding stock. Why shouldn't we get ownership if we are forced to put still more money in? And along with ownership comes the right to the proceeds from selling the cleaned up banks back to the private sector. Personally, I want the taxpayers to get the benefit of this and not bank stockholders or managers who led us into this morass in the first place. And that's precisely what would happen if the government simply took the bad assets off bank books at any price that still left them solvent.
Third, it is very important both for our current political imperatives as well as the future incentives for our capitalist system that bank stockholders and managers take the hit for their monumentally bad decisions. There is no love for either of these groups today, making such a solution a politically good one for all sides, but more important is the need in the future for the next set of owners and managers to think twice, and even three times, before making decisions that threaten the health of the global economy. They will only do that if they understand that making a bad decision will cost them personally. Besides, that's capitalism ain't it? Heads you win and tails you lose. If this isn't an example of things coming up tails I don't know what could ever qualify.
So call this nationalization if you want. It would only involve temporary ownership. Government decisions would only be related to deciding which parts of the banks to sell off and which parts to hold on to.
Call it socialism if you like -- after all, those socialists in Sweden did exactly the same thing back in the 90s to virtually their entire banking system -- though it is worth noting the Swedish government actually made money on the deal.
I call it the cheapest and fastest way for America to have a banking system that is both financially viable and free of uncertainty.