Nationalizing banks poses risk but other options look worse

Original Link: http://www.chicagotribune.com/business/columnists/chi-tue-greising-nationalize-banfeb24,0,3132308.column

By David Greising

Each new term we add to the lexicon of financial disaster is a scary next step into the unknown. Last fall, there was the bank bailout, then the Detroit bailout. Next came the stimulus plan, and last week the great mortgage bailout.

And now this: nationalization, a scenario outlined Monday by analysts in which the government could end up controlling troubled banks.

The very word has connotations of the Great Depression and economic disaster. The last time the U.S. nationalized banks, we also faced 25 percent unemployment, bread lines, Hoovervilles and questions about the future of our democracy.

Nationalization is scary, all right. But so is the alternative: The malaise and mismanagement we have witnessed since the financial system started breaking down last summer.

Without nationalization—yet—taxpayers have spent many billions bailing out the banks, with precious little to show for it. Unless something is done, we may have to consult another phrase from the dictionary of financial distress: zombie banks, or those that do little lending, which leads to more lost time.

Can nationalization be much worse?

Granted, there are great risks to nationalization.

For starters, there is the basic philosophical quandary. It's tough for a country to take over a large swath of its banking sector and still tout itself as the first, best bastion of capitalism.

Execution risks abound too. University of Chicago business school professor Raghuram Rajan notes that nationalized banks would be subject to political pressures. They might weaken the economy by keeping failing companies alive. And nationalization would amount to a government rescue of bank bondholders, who don't deserve the help.

The economic arguments are persuasive. But they ignore policy realities that indicate a well-managed and limited nationalization effort could be a net benefit. Nationalized banks could serve broader interests, such as increasing lending and providing mortgage relief.

The effort to spur lending has had little discernible effect on private-sector banks. Taxpayers have invested $350 billion in the bank bailout so far, with $350 billion more on the way. The money has not had the intended effect of spurring lending or eliminating so-called toxic assets.

One sign of how this could be different came from Great Britain. Northern Rock, a bank nationalized last year by the British government, on Monday announced a plan to write $7 billion in new mortgages this year and nearly double that next year.

Scale those numbers up to a bank the size of Citigroup, which is eight times as large as Northern Rock was at the time it was nationalized. Imagine the lending power that could be unleashed.

A second major advantage is that nationalization would help eliminate the fear of the unknown that has become a major factor in the economic collapse. A nationalized bank would have less incentive to keep secrets about troubles hidden on its balance sheet.

The key question, then, is whether nationalization is done effectively or poorly.

"When the government says it's going to nationalize, does everybody believe we're going to have much stronger and more effectively capitalized banks?" asks James Barth, an Auburn University finance professor who was chief economist at the Office of Thrift Supervision. "Or does one think of something the government has mismanaged, like the Postal Service?"

Nationalization is nobody's first-choice rescue plan. There is a chance it could be done very badly. Done well, though, it could be an improvement over efforts to date that have not worked.