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Nationalizing a Bank?? You Really Should Read This!!

Posted by Larry Doyle on January 22, 2009 7:15 PM |

We had a few readers ask about the prospects and meaning of nationalizing parts of our banking system. For those who have already seen this Q/A, I beg your indulgence as I try to spread the importance of this topic to a wider audience. Also, to our friends MBC and his close cousin MPC, I hope you do not mind my sharing your questions.

Comment by MBC | 2009-01-21 21:15:32

 Hi LD,

Can you explain what the ramifications are if we nationalize US banks?  You had written in a previous thread, “the strong likelihood that the banking system in the United States has some form of nationalization. These are truly historic and challenging times and how this banking meltdown is handled from here will be both gut wrenching and critically important to our immediate and long term economic health and well being. We will be watching VERY closely.”

Thanks so much, remember like you are explaining to a high school student.

Comment by LD | 2009-01-21 22:02:46

MBC,

Well, given that we have never nationalized banks and had them continue operating all I can do is offer my opinion. We effectively have nationalized banks via the FDIC (Federal Deposit Insurance Corporation) but then paid off the depositors and closed the doors after selling off assets.  That is what I am recommending for institutions that are deemed insolvent.

This approach was taken in Sweden in the early ’90s and the economy recovered fairly quickly (a few years). In these instances, the shareholders are effectively wiped out. The creditors (people who have lent money to the banks) would get paid out up to the FDIC limit (250k) for individuals. For institutions which have lent money, they would have their repayment largely if not totally guaranteed by the government. Departments or divisions that have value could then either spin themselves off or be sold. After all this is done, shut the doors. The party is over. Why would such draconian steps have to occur? Simply because the losses on loans of all types along with losses on investments will have overwhelmed the capital in the bank.

The government may very well take the step of nationalizing the institution but continue to operate it in hopes of generating revenue to writeoff the losses. What is the risk here? That the losses on the loans and investments just merely get worse and it ends up costing even more money down the road than it would cost right now. This approach was taken in Japan in the ’90s and the economy did not turn around for a full decade (it is called The Lost Decade).  

In each of these scenarios we need to be aware that the motives of the government are far different than the motives of private capital. The government is here to serve the public welfare. The private capital is in business to serve the interests of shareholders. Given changed motivations, we can only assume there will be different business practices. Ultimately, we are trying to achieve not only stability in the banking system as a whole but growth and increased lending. Does this make sense? Hope it helps.

Comment by LD | 2009-01-21 22:11:46 

MBC, After writing my own response to your question, I just saw this article from the Wall Street Journal, “What if Uncle Sam Takes Over Your Bank?”  The people there must be monitoring NQ for ideas….(lol). I have yet to compare my reply to the article.

Having now just read the WSJ article, I hope that my comments with their detail fully clarify the nationalization topic.

~LD






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