Thursday, March 5, 2009

if the government cannot risk foisting losses on to debtholders, then it's difficult to see how America benefits from nationalisation.

From Free Exchange:

"Glossing over, with Paul Krugman
Posted by: | WASHINGTON
Financial markets

PAUL KRUGMAN has linked to Free Exchange before, so I assume that he sometimes has occasion to read it. Let me try to goad him, then, into answering a question for me. Mr Krugman seems to be strongly in favour of nationalisation. In a post from yesterday, he cites a speech made by Barack Obama on some of the differences between the Swedish banking system and the American banking system, which might complicate nationalisation in America. Mr Obama said:

So you’d think looking at it, Sweden looks like a good model. Here’s the problem; Sweden had like five banks. [LAUGHS] We’ve got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would — our assessment was that it wouldn’t make sense.

Side note, I'm going to start dropping [LAUGHS] into my posts, just to cue you all as to when I'm trying to be funny. [LAUGHS]

To respond to this particular line of argument from the adminstration, such as it is, Mr Krugman cites Martin Wolf, who writes:

The four biggest US commercial banks – JPMorgan Chase, Citigroup, Bank of America and Wells Fargo – possess 64 per cent of the assets of US commercial banks (see chart) [chart not available online]. If creditors of these businesses cannot suffer significant losses, this is not much of a market economy.

See, America only has four big banks, so it's no big deal. Fine, I don't care about the numbers of banks at the moment. I care about this, which appears just a few paragraphs later in Mr Wolf's column:

If it is impossible to impose losses on creditors, the state could well own huge banks for a long time before it is able to return them to the market. The largest bank restructuring undertaken by the US, before last year, was that of Continental Illinois, seized in 1984. It was then the seventh largest bank and yet it took a decade. How long might the restructuring and sale of Citigroup take, with its huge global entanglements? What damage to its franchise and operations might be done in the process?

I therefore have two questions for Mr Krugman. First, do you agree with Mr Wolf in his assessment that if creditors are not made to face losses, nationalisation could be quite drawn out and expensive? And second, to what extent will the government be able to make creditors suffer, given the potential threat to the financial system this may entail?

This is the very heart of the nationalisation question, because if the government cannot risk foisting losses on to debtholders, then it's difficult to see how America benefits from nationalisation."


Don the libertarian Democrat wrote:

March 5, 2009 16:16

When Cato said:

"Ceterum censeo Carthaginem esse delendam."

I don't remember him having to give a battle plan.

Seriously, there are some big risks with nationalization, and you have isolated one. I believe that Wolf is correct. I also believe that we should risk it. However, when Bernanke said this the other day:

“We have no structure — no legal and regulatory structure — that allows us to resolve in a safe and sound way a large financial international conglomerate,” he said. “We’re much better off, frankly, trying to resolve it within the context of continued operation than to allow it to fail and allow all the chaos that would occur following a bankruptcy.”

I took him to be saying that it would be a better alternative, but it's too risky and impractical. I believe that Geithner believes the same thing, although I'm less sure about that. It's a damned good point, and I'd be more sympathetic to it if I hadn't believed that we should try a version of the Swedish Plan, in which we did just what he's asking, back in September. By now, we might have a decent apparatus in place.

But the admission that these banks are, in fact, too big to fail, and that we are impotent to do anything about it except play along, should be understood to be a terrible indictment of our political and economic system. By propping it up, even for valid reasons, we are confirming that this crisis will have to lead to sweeping changes in our system, or this putrid embrace with banks too big to fail will remain. I simply believe that beginning the change now is a better alternative, politically and economically, than letting this embrace continue.

The solution would be for the Fed, Treasury, and FDIC, to be secretly planning this by, among other things, trying to talk to some of these creditors and doing a certain amount of preparation out of the public eye, at least enough to contain the fallout. So, we should not know that they have chosen to do this until they do it. Having said that, I will now end all of my comments like this:

The four biggest US Banks must be nationalized.

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