Is Nationalization The Right Solution?

The drums keep beating for bank nationalization throughout the blogosphere and even beyond. Today brings some rather unpleasant news on one of the government’s biggest companies — AIG — which ought to make us think twice.

There isn’t anything definitive out yet but here from Reuters is how it seems to be shaping up:

The revised agreement is expected to include an additional $30 billion equity commitment from the government, more lenient terms on an existing preferred investment, and a lower interest rate on an existing $60 billion government credit line, the source said. 

AIG will also give the Federal Reserve ownership interests in its Asia-based American Life Insurance (Alico) and American International Assurance Co (AIA) units, the source said.

Remember when we started down the road with AIG just a few months ago how simple this was going to be. Just loan them some money to get past the liquidity crisis so they could sell off the valuable pieces of the company. Why the taxpayer would probably make money on the deal. Now it appears as if we will own a couple of those valuable unsaleable assets.

Tyler Cowen writing in the NYT does a very nice job parsing the options we have with the big banks. He breaks them down into three courses of action:

  1. Shovel money into them as planned under the original TARP proposal. This was approach was abandoned as the complexities and expense of buying toxic assets became apparent.
  2. Nationalize them. The current rage. Cowen has some interesting observations on this that I’ll get to in a second.
  3. Nurse them along and hope they grow out of their problems. This is the view that I have come round to.

Mr. Cowen properly points out that nationalization has unintended consequences. You risk contagion as investors shun all banks due to government intrusion, the potential for politicizing the lending decision and the real systemic risk posed by wiping out the creditors of the bank. He also brings up a point which is just beginning to be discussed.

On top of that, the government doesn’t have the expertise to run large bank holding companies like Citigroup. There is the danger that caretaker managers, with bureaucratic incentives, will never return the banks to profitability. And restrictions on executive pay, already enacted into law, will make it hard to hire the necessary talent.

I don’t think that this point should be overlooked. Citi, Bank of America or any other large bank is a highly complex system. We aren’t talking about just a bank but a holding company with many pieces that do business in a number of different and arcane areas. As with AIG, many of the assumptions about exit strategies will probably be wrong if a major bank is taken over.

Several days ago I noted a post by Bronte Capital that suggested banks might be able to earn their way out of this mess. I said then I thought the idea made some sense and if you put it together with the options that Cowen outlined the “band-aid method” seems to be the least bad option right now. Arguably, we aren’t any worse off then we would be by adopting more pro-active approaches and we might just get lucky and see it work out.

I think we can all agree that we don’t need any more AIG’s.

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