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Debate: Nationalization of banks during economic crisis

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Are nations justified in nationalizing failing banks in the 2009/2009 economic crisis?

Background and context

During the 2008 and 2009 US and global economic crisis, nationalization of banks has been proposed by many sources as a way to restructure banks and stabilize the global financial system.
Paul Krugman, Allen Greenspan, Lindsay Graham, Nouriel Roubini and a long list of other journalists, economists, and politicians recognized the idea as a legitimate option or gave it outright support. This has sparked heated debate around the world, generally between those advocating for substantial government intervention during economic crises and those that advocate for more market-based solutions. The idea of nationalization became increasingly popularized as greater and greater amounts of money have been committed to "bailing out" banking and financial systems. The United States government, for example, passed a $700 billion bailout package in October of 2008 and a $787 billion stimulus package in February 2009, which included substantial capital for banks. With increasing taxpayer money and stake in the financial system, many demand a greater level of accountability to taxpayers through government control. Generally, this makes the idea of nationalization increasingly comparable to the status quo, which is part of why the proposal has gained some popular and political support in the early months of 2009.

Contents

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Ideology: Is the nationalization of banks ideologically sound?

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Pro

  • Ideological fears over "nationalization" of banks are overstated. Paul Krugman. "Wall Street Voodoo". New York Times. January 18, 2009 - "Washington remains deathly afraid of the N-word — nationalization. The truth is that Gothamgroup and its sister institutions are already wards of the state, utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks."


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Con

  • Nationalization of banks leads to socialism. Karl Marx wrote in the Communist Manifesto in 1848. - "The Proletariat will use its political supremacy, to wrest, by degrees, all capital from the bourgeoisie. Centralization of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly." This quotation presents evidence of the risks of opening the banks to government ownership. It creates a slippery slope to greater and greater state control and socialization over time. Those that argue that nationalization will only be temporary should not be trusted. Temporary nationalization is likely to lead to indefinite nationalization or other forms of state control and socialism. [1]


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Restructuring: Can nationalization help restructure bad banks?

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Pro

  • Nationalization is key to a swift and orderly restructuring. Federal Reserve chairman Alan Greenspan said in February 18, 2009 Financial Times article - "It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring."
  • If nationalization of banks works, it should be pursued. Lindsey Graham, a Republican senator from South Carolina, told the Financial Times. - "We should be focusing on what works. We cannot keep pouring good money after bad. If nationalisation is what works, then we should do it."[2]


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Con

  • No entities exist to buy-back nationalized banks. William M. Isaac. "Bank Nationalization Isn't the Answer". Wall Street Journal. February 24, 2009 - "for nationalization to work there needs to be a reasonable exit strategy. In the case of Continental, we had scores of options for returning the bank to private hands, including a public offering or a sale to any number of domestic and foreign banks and investor groups. [...] Today, who has the wherewithal, legal authority, and desire to purchase our largest banks? No one comes to mind, particularly if we rule out foreign groups, which I suspect would not pass muster due to national security concerns about ceding that much power over our economy to foreign powers."
  • Nationalization shrinks banks, worsening economic crisis. William M. Isaac. "Bank Nationalization Isn't the Answer". Wall Street Journal. February 24, 2009 - "Unlike the talking heads, I have actually nationalized a large bank. When I headed the Federal Deposit Insurance Corporation (FDIC) during the banking crisis of the 1980s, the FDIC recapitalized and took control of Continental Illinois Bank, which was then the country's seventh largest bank. [...] any bank we nationalize will be forced, both by the regulators and the marketplace, to shrink dramatically. We are in the middle of a serious economic downturn where deflation is a realistic concern. Do we really think that dismantling our largest banks would be helpful? I don't."


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Temporary: Can nationalization be temporary?

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Pro

  • Nationalization of banks during crisis would only be temporary The idea here is not to permanently nationalize banks, but, rather, to temporarily nationalize them while economic crisis persists. Once the crisis subsides and banks are stabalized and re-organized, they will be resold, thus ending their "nationalization".


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Con


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General solvency: More generally, can nationalization help solve crisis?

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Pro

  • Nationalization can be a last resort necessary evil during crisis South Carolina Senator Lindsay Graham said on This Week with George Stephanopolous, "Yes, this idea of nationalizing banks is not comfortable, but I think we have gotten so many toxic assets spread throughout the banking and financial community throughout the world that we're going to have to do something that no one ever envisioned a year ago, no one likes, but, to me, banking and housing are the root cause of this problem. And I'm very much afraid that any program to salvage the bank is going to require the government. ..."[3]
  • Nationalizing banks makes sense once in a century. Alan Greenspan said about nationalization, "I understand that once in a hundred years this is what you do."[4]


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Con

  • Bank nationalization won't solve fundamental economic problems Rick Newman. "Bank Nationalization: It's No Panacea". Seeking Alpha. February 23, 2009 - "It wouldn’t solve the underlying problem. The main problem at struggling banks like Citigroup is a mountain of losses – which the banks may not have enough cash to cover. Those losses are already a done deal: They stem from mounting defaults on loans given to homeowners over the last several years, and also to car buyers, students paying for college, and consumers who ran up credit-card balances they can’t pay off. [...] The government can pump taxpayer dollars into banks to help cover losses, which it’s already doing. But even if it owns the banks, 'the government can’t make embedded losses go away,' says economist James Barth of the nonprofit Milken Institute."
  • Banks must recover on their own, not via nationalization. Rick Newman. "Bank Nationalization: It's No Panacea". Seeking Alpha. February 23, 2009 - "The banks might recover on their own. There’s no doubt it’s going to be a tense year for banks, and there will be more failures. But the banks will recover when the economy does. Propping them up until then will require profound patience and probably a lot more money. But that may be a lot better than the alternative."


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Bad assets: Would nationalization help deal with bad assets?

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Con

  • It doesn't matter who has the toxic assets. The Government will be just as successful at handeling the assets as private banks are but the private entities will be better equiped to change with the markets when they recover. The Government worn't be able to change once the markets go to a normal state which means recovery will be much harder"
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Pricing: Can Nationalization solve problem of pricing bad assets?

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Pro

  • Nationalization of banks avoids problem of bad asset pricing. Fed chairman said that temporary government ownership would "allow the government to transfer toxic assets to a bad bank without the problem of how to price them".[5] The problem for private banks that Mr. Greenspan was referring to is that it is very difficult, if not impossible, to effectively price bad assets.


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Con

  • Nationalization does not solve problem of bad asset pricing. "Another argument is that banks’ dodgy assets are hard to value, making it impossible to know how much capital they need — and probably very expensive to provide it. True again. But nationalization doesn’t make these problems disappear. [...] If the government takes over a bank, the taxpayers tacitly acquire its assets, thereby inheriting all the uncertainties over valuation. And if a bank has negative net worth when it is nationalized, who do you think fills the hole?"


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Management: Can nationalization improve the management of banks?

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Pro

  • Nationalization of banks allows replacement of bad management. Through nationalization, the government is capable of replacing bad management with more capable and honest bankers. This will enable the long-term stability of banks.
  • Government can run banks more justly than greedy bankers. When taxpayer money is involved in bailing out banks, the government can generally more justly and equitably manage banks. Without government intervention, bailout money will be used to increase the wealthy of greedy bankers.


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Con

  • Bad managers are ousted at failing banks; nationalization unnecessary The failure bad banks resolves itself fairly naturally, with bad managers being ousted from bad banks. Nationalization will not help in this regard, and yet this is often an argument in favor of nationalization - that it will get rid of current managers. But, bad managers have already been ousted. So, what does nationalization achieve?
  • Current managers are best in crisis; nationalization won't help Somebody has to run banks. Those that are currently in management positions are better suited than those who are not. While some managers may be to blame for the crisis, the majority are doing a good job. If the goal of nationalization is to replace existing or bad managers, it will fail. It will remove the good as well as the bad managers.


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Tax cuts: Is nationalization superior to tax cuts and deregulation?

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Pro

  • Tax breaks for banks, over nationalization, rewards bad behavior. Banks are failing due to deep greed and risky behavior. Their business model has failed them and they should be held accountable. Nationalization helps uphold this moral imperative. Giving banks tax breaks does the reverse, rewarding bad behavior, and creating a very damaging moral hazard. Will other large corporations and businesses then feel free to practice highly risky behavior because they believe that the government will not only "bail them out", but also reward them with tax breaks and higher profit margins? For this reason, the idea of giving banks a tax break presents an extreme moral hazard.


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Con

  • Government should give banks tax cuts, not nationalize them. Deroy Murdock. "Just Say ‘No’ to Bank Nationalization". National Review. February 20, 2009 - "Rather than parrot Karl Marx, Greenspan, Graham, and other Republicans who have wandered off the ranch, Republicans should offer radical ideas — from the right. Why not help this wobbly industry by declaring a five-year federal tax holiday on banks? Let bankers improve their bottom lines and lend to worthy borrowers without worrying about the 35-percent corporate tax. Would that cost the Treasury tax revenue? Yes, but since Washington no longer checks price tags, why not try something that actually would stimulate rather than enslave banks? Improved economic growth and consequent decreases in government assistance could make this policy revenue positive."


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Moral justice: Does nationalization serve a form of moral justice?

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Pro

  • Taxpayer financing justifies government nationalization If the government is going to bailout the banking industry with hundreds of billions of taxpayer dollars, the banks no longer become simply private institutions. Taxpayers own a stake. And, the only way for taxpayer interests to be sufficiently represented is through the nationalization of the banks.


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Con

  • Bank nationalization would destroy significant wealth. Rick Newman. "Bank Nationalization: It's No Panacea". Seeking Alpha. February 23, 2009 - "A government takeover would vaporize a lot of wealth. This is why the markets freak out every time there’s a rumor, or a rumor of a rumor, about nationalization. If the government took over a bank, public shares would suddenly be worthless and shareholders would lose everything. With Citi and Bank of America shares down more than 90 percent over the last 12 months, many shareholders have already lost a fortune. But there’s still a chance they’ll get some of it back if the bank recovers. That potential upside would disappear if the feds stepped in. [...] Even worse, the banks’ bondholders and other creditors could lose a bundle too. Same with depositors and institutional customers whose account balances exceed the amount guaranteed by the FDIC. To prevent a panic, the government would probably cover those stakeholders up to a certain level – with taxpayers footing the bill once again."


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Sweden: Does Sweden's example demonstrate that nationalization can be successful?

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Pro

  • Sweden succesfully nationalized its banks during 1990 crisis. Sweden pursued a temporary banking nationalization strategy during the 1990s that succeeded at restoring banks to health and secured the Swedish financial system.


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Con


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Privacy: Does nationalization help or hurt personal privacy?

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Pro

  • Private banks are less trustworthy than government on privacy. It is an odd argument that government cannot be trusted with one's private information. Are private banks supposed to be more trustworthy? Private banks have a direct profit-interest in utilizing private information to further their profits. The government does not have this interest. Both are constrained by laws protecting individual freedom. But banks have a more perverse interest to utilize information in nefarious ways to expand their profits. Between the two alternatives of government and private/profit control of this information, government control through nationalization should be of lesser concern.
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Con

  • Nationalized banks allow government to violate privacy "Why Nationalization of the Banks is a Bad Idea". Free Republic. February 20, 2009 - "[Following bank nationalization,] government will have access to all our financial records. Now you may say that they do already and to some degree that is true but currently there are limits. If the government wants your records they need a good reason and to get them it usually involves law enforcement, a judge or the IRS. If the banks are nationalized government employees will have access to our financial records as a matter of course. There are two critical areas of privacy we once took for granted. One was doctor-patient confidentiality and the privacy of our medical records. That is disappearing under provisions found in the stimulus bill. The second is the privacy of our finances. The erosion of that sphere of privacy has been disappearing since the adoption of the income tax. Now any vestiges of our financial privacy will disappear. If our finances and records are under the control of the government, we lose a very important safeguard of our freedom."


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Pro/con sources

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