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The Meaning of Nationalization

Author: Lee Hudson Teslik
March 3, 2009

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For decades now, "nationalization" has been a dirty word in U.S. business circles. The term conjures associations abhorrent to most economists--from dysfunctional resource-rich nations seizing the assets of foreign companies to bloated European government structures suffocating on bureaucracy. A government taking control of private companies, many economists said, was antithetical to free-market policy and dangerously close to socialism. But with the largest U.S. banks facing existential challenges, economic urgency has upended the debate over nationalization.

The issue came to a head as policymakers debated how far the U.S. government should go to stabilize commercial banking behemoths like Citigroup and Bank of America. Both are strapped for cash--NYU's Nouriel Roubini reckoned in a recent column that they "look blatantly near-insolvent." The U.S. Treasury Department in late February initiated a series of "stress tests" (FT) aimed at gauging the depth of these institutions' financial problems, saying it would then determine whether to inject money through private markets or take control of the firms through the Federal Deposit Insurance Corporation (FDIC). Federal Reserve Chairman Ben Bernanke defended this course, saying such a takeover wouldn't resemble a "nationalization" (Bloomberg) in which the government "zeroes out the shareholders and begins to manage and run the bank."

What, then, does "nationalization" mean in this context? Many experts consider a bank "nationalized" if the government takes a controlling stake (SFChron) of its voting shares, even if it doesn't buy all the bank's shares. Since October, Washington has accumulated preferred, non-voting shares of many U.S. banks through its Troubled Asset Relief Plan (TARP). On February 25, the Treasury unveiled its new Capital Assistance Program, through which banks will be required to sell common stock (i.e. shares with voting rights) to the U.S. government if they cannot raise funds on the open market. The banks will have a seven-year window to convert the stock or buy it back, but some analysts still see this as veering perilously close to nationalization.

Given rising skepticism from the U.S. public over sinking taxpayer money into big banks, experts say the Obama administration has only considered taking on more public risk as a last resort. A collapse at Citigroup or Bank of America would likely have catastrophic systemic consequences, given the degree to which these firms support other major companies and the U.S. economy. As the financial crisis unfolded, banks like B of A and Citi bought up other banks and grew ever larger. In so doing, Roubini says, "the too-big-to-fail monster has become even bigger." Due to the urgency of the situation, even free-market hawks like former Fed Chairman Alan Greenspan (FT) and the editorial board of the Economist now say nationalization might be necessary. The question, they say, is not whether Washington should sink more money into banks, but how.

International precedent provides some lessons. Former U.S. Treasury Secretary and Secretary of State James Baker notes in the Financial Times that Japan's policy of pouring money into banks, without taking steps to reorganize their operational structure, created a network of "zombie banks" and led to a lost economic decade. Some experts say Sweden's bank nationalizations of the early 1990s are a more appropriate model. A policy paper (PDF) from the Federal Reserve Bank of Cleveland says Sweden's model worked because it was transparent; banks were managed by a politically and financially independent agency; market discipline was maintained; and the Swedish government quickly restored the creditworthiness of its underlying national economy.

The Economist, taking lessons from both the Japanese and Swedish approaches, argues for a temporary nationalization strategy that involves ascertaining which banks are insolvent; taking them over; and isolating their most toxic assets and selling them over time or holding them to maturity. Eventually, the banks could be broken up and sold--with gains going back to the U.S. taxpayer, who footed the bill in the first place. "Nationalization" is, of course, a loaded term--and analysts say whether a strategy such as the Economist's qualifies as nationalization is largely semantic. The most important point, they say, is getting banks to function healthily again, as quickly as possible.

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