Regulation vs nationalization

The Treasury today published its recommendations for regulating banks. For me, though, the question remains: why is regulation is superior to nationalization?
I ask for four reasons:
1. The case for regulating banks is entirely different from the case for regulating other industries. We do the latter for fear that, left to themselves, unregulated businesses will pursue profit maximization too aggressively, to the detriment of others - so drugs companies will skimp on testing, or railways will rip off customers*. But we regulate banks not because they'll make too much money, but for fear that, left to themselves, they'll lose too much.
Whereas ordinary businesses are regulated to protect others, banks must be regulated to protect themselves.  Which raises the question: if privately-owned banks can’t act in their own long-term interests, what is the case for private ownership?
2. The Treasury recognizes that existing ownership structures are flawed:

There must be major changes to the way that bank boards function. Improved risk management at board level, changes to the balance of skills, experience and independence, and a better approach to audit, risk and remuneration are required. Institutional shareholders need to be more actively engaged in monitoring the board of the bank in which they have invested.

But if ownership is the problem, why use regulation and exhortation? Why not take direct control and structure banks better?
3. Nationalization helps ameliorate the principal-agent problem within banks. Banks failed in part because key employees were paid huge bonuses for short-term performance, and thus took too much risk. This has led to calls for lower, or longer-term bonuses.
But each individual bank finds it hard to follow this advice. Each one fears that less lavish bonuses will cause “talented” staff to leave for banks that do pay extrvagantly.
However, if banks were nationalized, this co-ordination problem would be reduced, as nationalization would allow all banks to pay lower bonuses. Then, “talent‘s” options would  be fewer, to go abroad, or start up a new bank.
4. The notion that nationalized banks are bad for the economy might be mistaken. This new paper claims that:

The view that government ownership of banks is harmful to economic growth is unjustified. If anything, our findings suggest that government ownership of banks has been associated with better long-run growth performance.

One reason for this is that, even if privately owned banks do engender small gains in allocative efficiency, these can be wiped out by the huge costs of banking failures; it takes only one Okun gap to offset many savings of Harberger triangles.
Now, I am not saying here that nationalization is a good idea. It’s certainly not sufficient for good bank governance, although it might be necessary; our current passive control of Lloyds and RBS is inadequate. I’m just wondering why the government regards nationalization as a desperate last resort rather than a reasonable policy option.
* For present purposes, let’s ignore the merits or not of this argument.

Comments

[William]

The main problem with banks is that it is, currently, very hard to let them go bust. Surely regulation should be aimed at making bust banks relatively harmless, by e.g. providing ways to wind them up safely, rather than deciding who gets paid what? And to wind them up in a way that ensures the managers get nothing. They might be less inclined to take risks then.

[Luis Enrique]

What kind of banks are you talking about, and do you think it matters? Are the arguments for nationalising a high street bank (consumer, small business, mortgage) different from the arguments around nationalised investment banks?

[john b]

"if privately-owned banks can’t act in their own long-term interests, what is the case for private ownership?"

That under government ownership they'd be no better, or possibly worse, at acting in their own long-term interests?

[chris]

@Luis - I was posing a question, rather than suggesting a blueprint. But one possible model might be "utility" banks in public ownership, alongside small (ie small enough to fail) private (investment?) banks, which needn't be so tightly regulated, if at all.
@ John B - I grant that the track record of publicly owned businesses is not great/ But have we really exhausted all the possible ways in which they might be run?

[ad]

"The case for regulating banks is entirely different from the case for regulating other industries."

I thought that the case for regulating banks was that if a bank fails it creates large negative externalities in a way that the failure of an ordinary company does not do.

Left to themselves the banks would therefore put less effort into avoiding failure than is optimal for the country as a whole.

But simply forcing a company to do something that it would not otherwise do does not require full-scale nationalisation.

[Mark Wadsworth]

The mistake that you are making (and that most of us make) is to talk about 'banks' as if they had a mind of their own, or were somehow distinct from their senior employees.

They don't, and they aren't. It's the relatively senior employees who run the 'banks' for their own personal benefit. When you say 'banks lent recklessly or 'banks paid big bonuses', what you really mean is 'senior employees lent recklessly' and 'senior employees paid themselves big bonuses'.

The answer to all this must be that somehow 'senior employees' (however defined) have to run banks as partners with unlimited personal liability. Individual shareholders or bondholders, who have no say in the day-to-day running would be allowed limited liability, of course.

[Spango]

Addmitedly I've only skim-read your CEDI "Government Ownership of banks" Paper BUT;

Seems like it's analysing banks performance when a varying % of common stock is held by the government. And then seeing nationalisation as a natural endpoint of the spectrum.

Now, I may be naive, but I just can't agree with that. It just does not seem obvious to me that 70% ownership of common stock equates to 70% nationalised. Nationalisation infers ultimate control of the banking sector lies with government, 70% ownership only implies that governemnt has a role in descision making, and not nessecarily a 70% role, by any means. If you get me.

Also, by their own admission, the data is skewed by governement ownership rising in crisis situations. As they say, this puts paid to the simple analysis linking G ownership to poor performance. But they seem to pay no heed to the idea that crisis situations, by their nature, give rise to a greater politcal will to take painful, but ultimately correct, action.

Would we not expect to see government ownership to be most damaging during "goldilocks" times, when there is no public interest in economic matters, and vast electoral gains to be made by, say, overheating the housing market?

And doesn't their analysis likely under-report this by the very nature of its methodology?

[jameshigham]

Nationalization helps ameliorate the principal-agent problem within banks. Banks failed in part because key employees were paid huge bonuses for short-term performance, and thus took too much risk. This has led to calls for lower, or longer-term bonuses.

I'm afraid the BIS and Fed wouldn't agree on that summation.

[Tim Worstall]

"I’m just wondering why the government regards nationalization as a desperate last resort rather than a reasonable policy option."

Because even our current set of knobgobblers in power recognise that giving the next set of votestealers the keys to all the private capital of the Kingdom might not be a terribly good idea?

Jus' askin' mind, not a statement of fact.

[reason]

I'm with Mark Wadsworth on this. Go back to partnerships. Limited Liability means limited leverage.

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http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2009/07/marxism-the-mainstream.html#comments

[georges]

The present world banking crisis started because of political interference in the US mortgage market. Karl Rove wanted to turn poor US hispanics into home-owning Republican voters. So pressure was applied to give them sub-prime mortgages, which they could not hope to repay.

I would only support nationalization if this sort of thing was made constitutionally impossible.

[jordan 6 rings]

As they say, this puts paid to the simple analysis linking G ownership to poor performance.

[john b]

"The answer to all this must be that somehow 'senior employees' (however defined) have to run banks as partners with unlimited personal liability."

Nope, doesn't work: rewards are still asymmetric, as 1) bankruptcy doesn't entail slavery and 2) anyone in that position would hide sizeable amounts of their wealth in secret offshore accounts in case things went horribly wrong.

[Ravi]

It is really dangerous to think of nationalization. Nationalization does work in systems where we do not need free capital markets. But most of today's markets cannot operate without free movement of capital.

In my mind, true job of banks in capitalism is to collect and allocate capital efficiently. If we were to nationalize banks, do you think the nationalized banks can efficiently allocate capital? I have seen how nationalized banking system works in India - it does serve certain segments well, but efficient capital allocation in a democratic society? Absolutely NOT.

I agree with John B that incentive structure is an issue in many banks. That's where we need regulation, but NO nationalization. Government employees (i.e. public servants) are not designed to allocate capital.