Nationalize it, mon

petertoshThe sticking point in the lingering credit crunch seems to be the remaining toxic assets (or dodgy assets, as the Brits call them) on the balance sheets of so many banks, especially the big problem banks that are getting government bailouts or are in line for them.

The sticking point in the policy question of how to remove those toxic assets as an obstacle to normal financial intermediation seems to be valuation, i.e., as Winston Churchill is said to have put it, a matter of haggling over the price.   No small haggle, this.   It’s often said that there is no market for these assets, and that appears to be true in the sense that there seems to be an unbridgeable gulf between what banks say those assets are worth (97 cents on the dollar?) and what they’ll fetch on the open market (38 cents on the dollar?  The numbers are from a New York Times article, 2 Feb. 2009, and refer to a particular mortgage-backed bond.  A division of Standard & Poor’s estimated the bond’s value at 87 cents or 53 cents under a less optimistic scenario. )  Treasury Secretary Tim Geithner’s plan for the remaining $350 billion of last fall’s bank bailout is due to be unveiled Tuesday, and advance word is that it calls for the Treasury to buy up a lot of those toxic assets and quarantine them in a “bad bank.”

Bush Treasury Secretary Henry Paulson’s original plan called for the Treasury to buy up toxic assets, too, before it was derailed by a chorus of boos from economists and the public, much of which seemed rooted in concern that the taxpayers would get ripped off.   Paulson II called for direct capital injections of the banks (i.e., the Treasury buys stock in the banks, giving them cash and improving their net worth), but it didn’t seem to do much to unclog the financial infrastructure.  Conventional wisdom is that the continued presence of those toxic assets on balance sheets is holding the banks back.  Thus Geithner’s new plan to buy them up.  But how much do you pay?

We’ll see what Geithner comes up, and I know it won’t be this, but temporarily nationalizing the big problem banks makes a lot of sense as an answer to this question (and a few others, too).   The virtue of nationalization is that it removes the issue of how much to pay for those toxic assets.  If the government buys up the entire bank and then divides into it Good Bank and Bad Bank, it can pay itself whatever it wants for those toxic assets that go in the Bad Bank.  Face value, nothing, whatever.  This simplifies things quite a bit.  When the Good Bank is back on its feet, the government can release it into the wild again with an initial public offering.  This is exactly what Sweden did, with pretty good results, in its banking crisis in the 1990s.

My former professor Willem Buiter goes even further, suggesting full (but still temporary) nationalization of the banks.  The rationale is that partial nationalization would discourage problem banks from disclosing their problems and reforming themselves, especially if nationalization involved salary caps or even termination for executives.  (This could be a fatal flaw in President Obama’s plan to cap bailed-out banks’ CEOs yearly pay at $500,000, too. My id still likes that plan a lot, though.)

UPDATE, Feb. 13:  Newsweek‘s Adam B. Kushner makes a fine case for nationalizing sooner (a la Sweden) rather than later (a la Japan).


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