Arguing about bank nationalization

We’re edging towards nationalizing the banks. First, the government announces plans to insure loans to small businesses, saying that credit insurance markets fail in recession - which makes them as useful as umbrellas that don’t work when it’s raining. And now, it is thinking of buying banks’ bad assets, thus saying - what we know - that banks can’t trade their way out of trouble.
All of which raises the question: if banks are failing so badly and need so much intervention, what is the point of keeping them in the private sector?
There’s one thing government can do much better than the private sector, especially in recession - raise finance cheaply. This means nationalized banks, operating with government guarantees, could raise money cheaper in wholesale markets. And it means governments find it cheaper than the private sector to inject capital (shareholders funds) into banks.
What, then, is the offsetting disadvantage of nationalized banks?
One moronic argument is that it’ll politicize lending. It needn’t. Government supporters don’t get a better service from the passport agency, win more premium bond prizes or get easier driving tests. Such examples show that it’s trivially possible to design a hands-off structure for publicly-owned services.
A less stupid answer is “worse management.”
But this is not self-evident. In principle, nationalized banks could operate in a quasi-market, competing against each other. The issue then arises: is it possible to design a contract to incentivize bank managers properly, encouraging them to make profits (that is, lend to good going concerns) without taking excessive risks?
Interestingly, the most powerful opponent of market socialism, Hayek, did not think this the decisive argument against state ownership. He granted - perhaps only for the sake of argument - that socialist managers “will be as capable and as anxious to produce cheaply as the average capitalist entrepreneur.”*
Instead, his concern was that market socialist structures would be unable (pdf) to discover the “right” market-clearing prices.
However, the private sector failed to solve these issues. It didn’t incentivize bank bosses and employees properly, and privately-owned banks failed to price assets correctly, paying way to much for mortgage assets. 
The alleged failures of state ownership are therefore failures of private ownership too.
Now, I’m not arguing here for nationalizing banks. I’m just making three points.
1. Can we discuss this without ideological blinkers? On the “left” there’s a tendency to regard the failures of markets or private ownership as inherent features of the system, whilst failures of government are mere accidents. The “right” makes the opposite error.
2. Can we think about organizational and incentive design? The dominant ideology in the public and private sector is that we don’t need to do this, and that any organization just needs the right leader. Isn’t it time we thought a little more?
3. Nationalization is not the end of the story, but the start. It just opens the question: what should be the business model and organizational structure of a nationalized bank? It’s possible that the government failed to consider this adequately when it took over Northern Rock.
* p196 of this book.

Comments

[Luis Enrique]

Politicization may be a moronic argument if meant as Labour supporters would get loans and Tories won't. It's not a moronic argument if you are worried about a state run bank being reluctant to let failing firms fail and/or too ready to lend to politically fashionable projects (perhaps "regional manufacturing"). Handing out passports and administering premium bonds are very different kettles of fish to making decisions under uncertainty without objective (measurable) criteria, like deciding whether to extend credit to a loss making firm. When trying to stave off a recession, this sort of lending ('zombie') might do some good; the long-run consequences are less happy. You might be right that some intelligent incentive design could overcome these worries, but contract theory runs into trouble when characteristics and outcomes are unmeasurable. What do you think the incentives faced by loan managers and bank directors in a nationalised bank would look like?

I'm always puzzled by this idea of the government forcing the banks to lend? Is it based on the idea that there a profitable lending opportunities (that is, loans that will be repaid) not being made for some reason? If that reason is lack of capital, then recapitalisation in the answer ain't it? Or is the argument based on the idea that there is ample capital, but profitable lending opportunities are still not being exploited for some reason? Or is the argument even based on the idea that right now we want lenders to lend even if expected returns are negative?

[tbrrob]

"Instead, his concern was that market socialist structures would be unable (pdf) to discover the “right” market-clearing prices.

However, the private sector failed to solve these issues. It didn’t incentivize bank bosses and employees properly, and privately-owned banks failed to price assets correctly, paying way to much for mortgage assets."

You assume that there is something wrong in this and that all banks/investors did this.

I take the Jim Roger's argument that the bad banks should have been left to fail. Allowing for good banks and investors to step in and pick up the pieces. Painful -- yes but we're not going to get out of this free of damage whatever we do.

The problem with banking is not banking itself. It's us, the people.

Most people don't realise there is an inherent risk in banking. That when you put your money in a bank you are exposing it to risk. And therefore in certain circumstances you may lose it.

Admitedly there is a slight con in banking in the way they sell their accounts. A savings account is far from safe -- it should really be called an investment account.

People have to accept though that a bank isn't necessarily a safe place to store all their money and that they should look for alternatives. Essentially people need to become more risk averse.

However this is not going to happen if we continue proping up banks.

[tolkein]

What you're really arguing is that structures do matter - contrary to the managerialist view that what mattered was standards: better managers would do a better job. This is a state socialist view, and why I would be very nervous of any more state control of banking/industry. We'd see more leadership principle in action and more direction in lending and less competition. A structures solution is messier and needs lots of competition - which needn't be capitalist, but is more likely to be - to find.

I once made a presentation to the Board where I pointed out that in 1948 what became the GDR had 120% of the per capita income of the FRG. The Germans were as clever in the East as the West, but 40 years of state socialism put real per capita income in the GDR at 20-25% of FRG. Structures do matter. (It was pointed out that I'd pretty well accused the Board of being like the Stasi.)

Designing incentive structures that work for shareholders as well as managers is going to be messy and difficult, even if the long term payoff is likely to be high.

[Alex]

I pointed out that in 1948 what became the GDR had 120% of the per capita income of the FRG.

Cite? I doubt this; the Ruhr wasn't in the GDR, neither were the major ports, or the commercial cities of the Rheinland and the south-west. The GDR had to do a lot of investment in extracting and upgrading brown coal and other low grade mineral resources because all the good stuff is in the Ruhr or the Saar, and the farming ain't great on the Brandenburg plain either.

They did have a lot of the electrical and chemical engineering complex around Berlin, but that wasn't in a great condition by May 1945, and the Russians took a lot of kit away as well.

If that was based on prewar statistics it could be drastically out.

[Sam]

I'm not sure that you can really argue that the state can run a hands-off bank because it can run a hands-off passport service. Issuing passports is a narrow and well-defined task: you check that the person is who they claim to be and is a British citizen, and you issue them a passport. It can be done well or done poorly, but there's no political gain in "issuing more passports".

We are already seeing politicians demanding that banks should issue more loans. If the state actually owned the banks, it seems implausible that politicians would make fewer demands. A state bank isn't going to prefer government supporters to opponents, at least on a global scale (there's always room for a nice bit of cronyism, though), but it has to be hugely vulnerable to being told to make more loans to poor people, say, or to encourage (or discourage) buy-to-let mortgages or whatever.

[diogenes1960]

Government supporters don’t get a better service from the passport agency, win more premium bond prizes or get easier driving tests.

Have Blunkett and Prescott been forgotten already?

[Bob B]

IMO it's worth reading Robert Preston today (Saturday) on: A bank insurer, not a toxic bank:
http://www.bbc.co.uk/blogs/thereporters/robertpeston/

For the present at any rate, policy is moving away from creating a "toxic bank" or nationalising the banks towards an asset insurance scheme to protect the banks from the consequnces of all those foolish investment decisions they made. The banks would pay a fee for the insurance cover.

Also in today's news:

"Britains biggest banks are 'technically insolvent', Royal Bank of Scotland said yesterday, as the global banking industry was rocked by another day of turmoil, including the announcement of $23bn (£16bn) of new losses from Merrill Lynch and Citigroup, the giant US institutions."
http://www.independent.co.uk/news/business/news/british-banks-are-technically-insolvent-1418229.html

[Laurent GUERBY]

"40 years of state socialism"

No one is talking about setting up a non democratic state.

And, since institutions do matter a lot, I don't see how you can project a non democratic state econ data to functionning democracy state without tons of correcting factors.

[Bob B]

News update:

"British taxpayers could face a £200bn liability for bad bank debts under government proposals for a huge 'insurance scheme' to ease the burdens of high-street lenders."
http://www.independent.co.uk/news/uk/politics/taxpayers-could-be-liable-for-pound200bn-in-toxic-bank-loans-1418912.html

"Whitehall sources said that they had discovered that some major UK lenders - including RBS, HSBC and Barclays - have had only 20 per cent of their balance sheets made up of 'traditional' loans to UK households and firms.

"Meanwhile, up to 80 per cent is tied up in loans to foreign nationals and companies, bond issues and other investments."
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/4278583/80-per-cent-of-bank-lending-went-overseas.html

[tolkein]

Alex The source was Mary Fulbrook "A history of Germany 1948-1990. "

[Navaid]

Ummm ... do we propose nationalizing all banks and creating one super duper Bank of USA? Otherwise, how exactly do we nationalize citibank or others and allow this bank which now has access to cheap public funds to compete fairly with banks that are doing well?

Government is not the answer. Private industry may be wrong and may have done things improperly but don't forget the ever watchful eye of Greenspan (part of the Fed) that allowed things to unfold as they did.

Now that banks are demanding proof that a borrower is credit worthy (imagine that novel concept) ... government wants the banks to reduce their restrictions?? What the hell? You cannot solve this mess by loaning indiscriminately ... that is what got us here in the first place.

[Debt Consolidation Companies]

Nationalizing the banks seems to be a great idea, but when you get into the details and you investigate more about it, you'll find it some how similar with what we have right now.

[patek philippe watches]

This is just one idea, and perhaps displays no more than my limited imagination. If there are better ideas out there, that amount to more than "implement something called "market socialism" and then - alacazam! - full employment!" then I'd love to hear them. http://www.watchgy.com/ mostly bank deposits, fell by £143.2bn in Q1. And of course there’s no guarantee such buying will continue.
http://www.watchgy.com/tag-heuer-c-24.html
http://www.watchgy.com/rolex-submariner-c-8.html