The Case for Nationalizing the Entire Economy

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U.S. Treasury Secretary Tim Geithner (5th R) speaks as he meets with outside experts to discuss oversight of Troubled Assets Relief Program (TARP) at the U.S. Treasury

The advocates for nationalizing U.S. banks have been out in force recently. Senator Lindsay Graham, who almost certainly does not have a PhD in economics or finance told ABC News that banks were in such deep trouble that government ownership of the institutions may be the only way to save the financial system. Economist Nouriel Roubini, who probably has several advanced degrees, wrote in The Washington Post that the Swedes set a precedent for bank nationalization nearly 20 years ago. The first counter to his argument is that it is dark over 20 hours a day in Sweden during the winter which causes a level of depression among the population that may undermine their judgment and views of how dire any economic situation is. If this theory is true, banks in Panama will never face being taken over by the government.

Disagreeing with Roubini has not been rewarding. He predicted the current economic collapse with precision long before most economists. His forecasts for the next year or so seem reasonable and are widely viewed as a good road map for what is likely to be ahead for GDP and employment. However, he may not be right with his estimate that total banks write-offs due to toxic financial instruments sold by U.S. will be about $3.3 trillion worldwide. That is well above projections by most economists and the IMF. Nationalization of U.S. banks would cause hundreds of billions of dollars of losses to the common and preferred stockholders in the firms. This, in turn, could cause the failure of some investment funds that hold those shares. (See pictures of TIME's Wall Street covers.)

Nationalization would obviously make taxpayers responsible for the losses these banks may experience in the future. But, the taxpayer is already likely to face that fate. The federal government is in the process of guaranteeing bad paper at the banks and may end up buying many of these toxic assets to keep losses at the firms at a level where they do not have to raise even more capital.

Nationalization seems tempting because it seems simple. The U.S. owns the banks. They continue to do business as usual, but their balance sheets become, in essence, the balance sheet of the Treasury. In theory, as time passes and the banks become profitable, those profits go back to the government and pass though to citizens in the form of lower taxes. The banks may also end up being sold back into the private enterprise system bringing the government an even better return.

Bank ownership becomes more complex when a firm owned by the government does something materially different from what its competitors in the private sector do. If bank owned by the government offers business loans at 3% interest, what does a foreign-based public bank like DeutscheBank do to match that? A government-owned bank can be driven, at least short-term, by policy and not profits. That puts financial firms in the private sector in peril whenever they try to compete. The relationship between a national U.S. bank and private banks both inside and outside the U.S. causes a series of inequities within the system.

Banks lend money to one another and charge interest in the process. The risk of borrowing from a firm owned by the government should be extremely low. Borrowing from a U.S. regional bank is, on paper, more risky. All inter-bank borrowing would almost certainly move toward taking money from the firms backed by the government balance sheet. Interbank lending among private banks could disappear.

A national bank is almost certain to follow practices which are unsound, which would not make it terribly different from the large firms that helped get the economy into trouble. Bank managements bought toxic assets two or three years ago. A government-controlled bank might offer mortgages at extremely low rates, rates so low that they clearly do not take into account the level of home loan defaults. From a policy standpoint, it may make "sense" to do that to help buttress the housing market. But, to some extent that moves the government's control of the credit system from nationalizing banking to nationalizing the home lending system. The government could decide to apply the same principles to consumer credit loans and business lending.

It may just be a better idea to nationalize the entire economy and be done with it.

Douglas A. McIntyre

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