Krugman responds to Alan Blinder's anti-nationalization argument

[flpoljunkie]

March 8, 2009

Anti-nationalization arguments

A quick note (quick because I’m on deadline for the column) on several arguments out there:

1. I just don’t understand a lot of what my colleague Alan Blinder wrote. In particular, I don’t understand how the good bank/bad bank solution is possible unless you pump in large amounts of public funds.

You might say, why can’t a bank just split itself, giving the bad stuff to one piece and the good stuff to the other? Because it has to divvy up the liabilities as well as the assets. And if it gives the bad bank (which isn’t solvent) a bunch of the liabilities, this amounts to defaulting on its debts — and the bondholders will sue. So the good bank-bad bank thing seems to implicitly carry the assumption that someone, namely you and me in our capacity as taxpayers, guarantees the bad bank’s liabilities. In which case we are in fact nationalizing the losses, but privatizing the gains. Which brings us to:

2. An anonymous poster at Free Exchange (hi, Ryan) berates me for not taking on the question of how many losses to foist on bond debt holders, “because if the government cannot risk foisting losses on to debtholders, then it’s difficult to see how America benefits from nationalisation.”

OK, I disagree totally with that premise. The benefits from nationalization come from (a) giving taxpayers a share of the upside rather than just a share of the downside, which is where we are now (b) ending the gaming of the system, even looting, that is encouraged by the current system of implicit guarantees (Simon Johnson has been very good on that) (c) making it politically and fiscally feasible to put in enough capital to revitalize the system. These advantages are there whatever you decide to do with junior bank debt.

That said, some decision must be reached on bank liabilities. Sweden guaranteed all of them. If forced to say, I would go the Swedish route; but of course we can’t do that unless we’re prepared to put all troubled banks in receivership. And I’m ready to be persuaded that some debts should not be honored — this is a deeply technical question.

What’s clear, however, is that the current system, of implicit maybe-kinda guarantees on bank liabilities — call it wink-wink-nudge-nudge-say-no-more banking policy — is failing badly.

http://krugman.blogs.nytimes.com/2009/03/08/anti-nationalization-arguments/#more-1559

Blinder's op-ed in today's NYT: Nationalize? Hey, Not So Fast!

http://www.nytimes.com/2009/03/08/business/08view.html?ref=business

[Median Democrat]

1. Interesting - Both Blinder and Krugman Are Keynesian Economists

Neither of them are knee jerk monetarists, so it is interesting to see them in a debate over nationalization.

I do agree with one point raised by Blinder, which Krugman never addresses: The logistics of nationalization. Krugman always discussing nationalization on theoretical terms, but he never addresses whether the federal government currently has the employees to accomplish such a task. For example, the FDIC is currently hiring people to address a shortage in employees. How could the FDIC take on the nationalization of even onr, let alone three or four, mega banks?

[ProSense]

2. Interesting. Thanks. n/t

[annabanana]

3. With the "good bank/ bad bank" plan... isn't that just the old dodge of

privatize the assets & nationalize the debts?

[karynnj]

4. This is interesting and it seems that there is

substantial agreement between the two economists on the problem. They even seem to identify some of the same problems. Where they disagree seems to be in which plans down sides are the worst.

I like Krugman's concern that the taxpayer share in the upside, getting part of the gains. But, the question is whether there is anyway to structure a plan that avoids the downside caused by nationalizing the 4 biggest banks - in effect nationalizing 60% of that market, but insures the taxpayer "owns" enough of the bank to get a fair % of the gain - when it happens. Then again, if the government "owns" almost the entire bank and it is still run by the original or replacement bankers, other than having stockholders still owning a small piece, how would that differ from nationalization where they retain workers?

[girl gone mad]

5. Yves Smith wrote an excellent critique of Blinders piece.

It's long, but worth the read (or listen)

http://www.nakedcapitalism.com/2009/03/amazingly-disingenuous-piece-by-alan.html

an excerpt:

Before I start shredding "Nationalize? Hey, Not So Fast," by Alan Blinder in the New York Times, let us first go back to the basic problem,, nomenclature. Blinder does not specifically do so in this article, but opponents to nationalization often raise the image of enterprises being expropriated by the state, in other words, healthy (or at least viable) businesses being stolen.

We have the reverse here. Instead a transfer of wealth from the private sector to the state, we have the state (as in the taxpayer) propping up businesses and keeping management demonstrated to be incompetent, perhaps corrupt (let us not forget that overcompensation in phony good times is tantamount to looting, and liberal accounting appears to be awfully common) in place.

The normal remedy for failed businesses is to let them fail. But we don't do that with banks. The big fear is depositor runs, and if that were to occur on any scale, it would indeed bring the entire system down.

Quite a few readers have said something along the lines of: "I'm opposed to nationalization, the banks should be put into receivership." Hate to tell you, they are the same thing.

When a bank fails (technically, the relevant regulators, often state level, deem it to be insolvent, and the FDIC rides in) the FDIC does "own" it. The assets and liabilities are in the hands of the FDIC, it determines how to dispose of them. However, its preference is to seize the bank on a Friday and have the deposits and branches in new hands by Monday. The fact of FDIC ownership is thus not apparent to the public. However, when Continental Illinois failed in 1984, it took nearly a decade for it to be sold (I forget the details, but if my recollection is correct, a reader said it was a real garbage barge).

The other big, BIG, problem is terrible incentives. Management has nothing to lose by taking risks, and to get out from under the governments' intense oversight and pay caps, its reason to take aggressive risks as great, if not greater, than before. And now there are no shareholders to take the first hit, say by dividend cuts (with stock prices trading at option like levels, anyone who still holds the shares of the big banks is either a punter, not an investor, or very asleep at the switch), and pay and staffing levels already under pressure, the downside of any miscues comes out of the taxpayers' hide.

http://www.nakedcapitalism.com/2009/03/amazingly-disingenuous-piece-by-alan.html">More...