Why we were right not to nationalize the banks

By Felix Salmon
October 5, 2009
admitted I was wrong about bank nationalization, I've received a lot of pushback along those lines. Charles's comment is representative:

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Normally, when I admit that I was wrong, I don’t get a lot of responses basically saying “no, you were right the first time round”. But this time, when I admitted I was wrong about bank nationalization, I’ve received a lot of pushback along those lines. Charles’s comment is representative:

Really ? How did you come to that conclusion? As far as I can see, the “saved” banks are retreating on lending to SME and retail, stuffing their balance sheet with safe bonds (mainly govies) and recapitalizing themselves by taking advantage of the steepness of the yield curve. This has enormous opportunity costs for the taxpayer (these long bonds coupons will have to be paid one day…), depresses the “Real” economy, and is as close to “free lunch” for the banks than anything. The government, and the taxpayers, bear the burden of banking sector losses and get nothing in return. A nationalization has the same risks, but enjoys the potential upside.

One key point of my post was that the Obama administration is very good at tempering its initiatives with a clear-eyed view of what is possible and what isn’t. In the case of the decision not to nationalize the banks (which, it’s worth emphasizing, is different from a decision never to nationalize the banks), I think we’re seeing a real appreciation of the breadth of the possible unintended consequences, as well as the practical impossibilities involved in the government trying to run such an enormous banking book with so many different and competing parts.

How much of the decline in bank lending to individuals and small businesses is due to a drop-off in demand, and how much is due to banks’ increasing risk-aversion? It’s hard to say, but the former is clearly important, and having government-owned banks wouldn’t change that. Such lending is normally much more profitable than the big wholesale loans which banks have increasingly been keen on extending of late; that says to me that they’d be perfectly willing to make smaller loans if only there were reasonably high-quality demand out there. I might be wrong, but even if I am, it’s hard to see how government ownership would change things: government simply doesn’t have the ability to micromanage bank lending at that level.

The reason why I wanted to nationalize the banks is that they were suffering from a major liquidity crisis, and they were insolvent on a mark-to-market basis. In that situation, the government essentially has two options, when the banks are too big to fail. It needs to provide liquidity either way; the only question is whether it does so while taking ownership, or whether it leaves the banks to continue in their existing form, in the hope that the markets will recover and they will no longer be mark-to-market insolvent.

The latter is much easier, and is pretty much what happened. It also has the added advantage that you don’t have government ownership driving out private-sector risk capital. As an anonymous Treasury official says in Lizza’s piece, “People had money to put into banks. The nationalization crowd would have had the government putting all that money in.”

It’s true that when the government determines that a certain bank is too big to fail, and then lowers interest rates to the point at which the yield curve becomes steep, the result is a recapitalization of that bank through easy profits. And yes, those profits go to the bank’s private shareholders. You can call that a free lunch. The alternative, for taxpayers, is the possibility of a very expensive lunch indeed. Here’s Lizza again:

Furthermore, Summers said, there was a medium-term risk that nationalized banks would lose value, in the same way that the act of foreclosure decreases the value of a home. Summers pointed to the example of Sweden, which was regularly cited by economists who favored nationalization. But Summers noted that Sweden didn’t nationalize for two and a half years, by which time the situation had become so severe—interest rates had reached a hundred per cent—that there were no other options. In addition, Nordbanken, the largest bank nationalized in Sweden, was already eighty per cent government-owned. Summers concluded by emphasizing that nationalization was a strategy that governments turn to only after it is very clear that nothing else can work.

One of the problems facing Summers and Geithner when they made this decision was how to get the wholesale market in bank debt moving again. (Remember the TED spread?) Given that they couldn’t nationalize thousands of banks at once, and given that nationalization was tantamount to an admission that the banking system was insolvent, non-nationalized banks would have found it pretty much impossible to find funding at any level, and there might well have been a much larger number of bank failures than we’ve seen to date.

The fact is that nationalization is a negative-sum game. Just because banks are making large profits now, doesn’t mean that they would have made just as much under government ownership. And the political noise surrounding just about any decision that any nationalized bank made, especially as regards pay and bonuses, would have made any other kind of reform (healthcare, financial-regulation, you name it) even more difficult than such things have turned out to be sans bank nationalization.

Now that the results of the stress tests have been made public and the debt market has recovered impressively, there’s a strong case to be made that the banking system is no longer insolvent. If we could get here without the incredibly drastic measure of nationalization, that’s a good thing. Yes, we might have lost a bit of potential upside on our hypothetical equity stake in the big banks. And yes, it’s very depressing to see a large chunk of that upside going to the very bankers who helped drive the economy into the current recession in the first place. But let’s not kid ourselves that the nationalization option would have been trivially superior in all respects.


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I believe that the capitalist vision has been lost in countries/economies that say that they function in this manner. In the capitalist system poorly run business need…have to fail. If this can not happen in an-orderly fashion they should be stabilized then torn limb from limb. Any company that received alphabet soup assistance has to be disassembled and sold. If this doesn’t happen we are working in something other then a capitalist system Losers have to lose and winners have to be able to pick up the pieces.


Posted by JohnL | Report as abusive

It really doesn’t seem to matter anyway. “The country [globe?] is mined beneath our feet.”

Felix, you are wrong about everything you blog about. I’m horrified with the things you write, please stop blogging on Reuters.

Posted by Dogma | Report as abusive

Another way of looking at it, though, is that deciding not to nationalize was a risky gamble that happened to pay off. But knowing in retrospect that a risky gamble turned out to be successful is not an argument that the gamble was the best choice at the time.

Suppose I win a dollar by surviving a round of Russian roulette, collect my dollar, and then assert that playing the game was a good decision.

It’s premature to declare victory, although the great “muddle through” strategy has worked better than I would have expected to date. Real estate is not remotely out of the woods yet, with more foreclosures than banks can process and the still-looming mountain of option ARM recasts over the course of the next three years or so.

But the can has been kicked a little way down the road, and that’s not nothing. Can-kicking doesn’t get the respect it deserves at times. In the long run, we’re all dead, after all.

Posted by Craig | Report as abusive

That’s Summers-grade asshattery! Well done sir.

If you are making the limited point that nationalization would have been worse than what was actually done, I would agree with you. If you are saying that nationalization was better than allowing for an orderly liquidation of the banks’ assets, converting the debt to equity, and putting the bank’s assets in the hands of people who know what they are doing, you are quite wrong. Because the free market dare not be trusted when the all important welfare of corporate America was threatened, you and future generations of Americans (and Brits) will be much worse off in the years to come.

Posted by maynardGkeynes | Report as abusive

Felix that sounds like dangerous independant thinking. Just like USA’s foreign policy in decades past was to obliterate Cuba and Vietnam among many others to prevent a potentially superior socialist model of development from emerging, banks didn’t even allow a single Nationalization as a test because they knew it would end their useless trading.
But you are using independant arguments that aren’t towing the finance industry line. When the purges come you better move to Boston or Seattle and the Bay Area or somewhere commie.

Posted by Phillip Huggan | Report as abusive

The banks should not be nationalized.

1) Banks are backed up by the Fed, which has unlimited liquidity powers. No other industry has such backup. The Fed did issue trillions in liquidity to bailout the banks.

2) Let them fail when they can’t make it. You have Fed, and you have FDIC to clean things up. That’s the way it should work. Moral hazard must end.

3) Major American banks are different from just about any other foreign banks. Over the decades they have become grotesque all-consuming greed machines, a bunch of financial Enrons. No government with any sanity would want to take them over. These banks cannot manage themselves, lest managed by the government. Fixing the mess their bankruptcy left behind is easier than nationalize them. Even when nationalized, one has to liquidate them immediately.

Posted by The Real Deal | Report as abusive

To clarify, the previous lack of decorum was directed at 3:25. Larry, is that you?

Dear Mr.Felix Salmon,
Well and wish to hear the same from you.
I am a regular writer by comments on various subjects to this websites.
Many comments were published.
I have no time to take all my published comments from this website,and more occasions, it was disappeared or oops words found or gone into this website!s old storage.
If these things happens always, my freedom of expressions by hour long writings may not be known or written or seen to its users, its new members, my relatives, my students and my friends in India and in abroad.
Back to your writings, i have already written that,Why In America, particularly many banks, financial institutions were in very bad shapes and were closed.
The above questions are still not answered by this world famous news provider either by eminent writings or eminent debates either to me by e-mail or any invitation to me on any circumstances.
i have studied economics, taking tuition classes for high school students on economics, civics,history,geography and English.
I think that , the successful Nationalization of many banks, merger of small banks to nationalized banks, some private insurance companies to nationalized insurance companies etc, by previous Indian governments.
Are they not producing remarkable results in terms of nation building, deposit mobilization, giving credits by many loan, attractive,affordable rates of interests to higher college education,self-help groups,small scale business enterprises,to state government agencies and to large scale industries from time to time.
Results are always quite encouraging and expanding these nationalized banks operations to every nook and corner of India.
In America, peoples mindset is quite different.
They are allergic to public enterprise and public participation concepts.
Because, Capitalism is deep rooted on their mind and on their day today set up.
What happened last three years banks were fallen like pack of cards.
How many Americans were lost their savings, retired peoples hard earned benefits from ex employers and these miseries are still shocking and created a severe panic and some mental agonies and all like bad happenings.
As per media reports, and from TV coverages, some well known, some executives ,some directors, and some investors are literally thrown out from their day today life.
To avoid for further damages, Nationalization of Banks, putting their savings in government controlled or supervised bodies are very safe and will have peaceful sleep for further few more years.
There are merits and demerits on any economic theory and its implementations.
Of course lending will give good opening and it will give good profits to banks and to financial institutions.
Since How Long?
All patch up work, policy exercises will be only temporary respite.Like taking rainy coats for rainy days.
It is like, in the mid night, if any body suffers sudden headache or fever or minor acidity problems, then we will giving some readily available ,prescribed tablets for purely ,temporary healing to that patients.
If Americans on entire majority thinking, nationalization of banks are not very good or not a permanent solution for past and present banks closes are left to find their own alternatives.
No existing economic theories or existing economic actions will erase it from bad to worse.

What happened to all the bank’s toxic assets? How much have they moved back onto their books? What makes you think they are actually solvent? I mean, really?

Posted by carping demon | Report as abusive

Concerning the Restructuring of the Global Financial/Economic System and Recent Discussion of Nationalizing “Banking” Interests

With regards to “nationalizing” Banks and other “investor owned” Institutions, we must be realistic concerning the inter-national composition of the investing institutions, corporations, and individuals.

Writing from a libertarian socialist point of view, I think it is necessary to clarify the objectives of any comprehensive program to re-dedicate private resources to a quasi-public mission and to consolidate equity and assets for the purposes of sharing the former and writing off the economically paralytic inflationary cost aspects of the latter.

In lieu of an economic system based on credit and equity trading, whose motivation is the underwriting of speculative ventures, we need to transform our fundamentally inflationary financial/economic system to one that is based on equity sharing and meeting the needs of people in the form of community betterment.

Such a financial system would be the right hand, the resource allocation facilitating function and services of an ambidextrous ecological, democratic, economic “plan and implement” economy that would respect and favor the sovereignty of villages/neighborhoods, educate-foster-facilitate-inculcate inter-community and inter-regional equality, unity and cooperation based on the basic principles of inclusion, equity, humanity, mutualism, altruism, quality of life (in lieu of standard of living), environmental/public health and wellness, sustainability, and peace.

Such a system would seek to establish a more just balance between competitive advantage and comparative advantage with the concerns of those indigenous to a community being paramount.

Such an economic system would recognize the necessity to embrace and implement conservation ethics for shorter term programs and projects of ecological economic redevelopment dedicated to survival pursuits and skills and its concomitant ubiquitous environmental improvement activities, and to the longer term programs and policies related to the legacy of the human race and its dominion (i.e. the recognition and respect of the resource limits imposed by a finite planet).

I call such a proposal an equity union and believe it to be a prudent and practical alternative to the extant economic/financial system. I believe such an economic rearrangement based on the fundamental mission of world unity and cooperation is the best hope for the purpose of entering an unprecedented era of peace and human progress and success.

Mike Morin
Eugene, OR, USA
(541) 343-3808

It wouldn’t have to be better in all respects.

If the insolvent banks had been allowed (forced) into bankruptcy, there is one thing that is certain. The same despicable people who brought us to the brink would not be doing it again, and would not be taking billions from the taxpayers.

That difference would boost American morale. That is reason enough for me.

These people are selfish bloodsuckers.

Felix: Don’t feel bad, we did nationalize the banks. Silly boy. Best, Chris

Posted by rcwhalen | Report as abusive

stylish, restrained and easy