The New "n-word": Nationalization

A number of readers who've commented to me about my recent blog on the financial crisis directed me to the March 3rd interview on NPR's Fresh Air with Simon Johnson, former research director at the IMF and now a professor of entrepreneurship at MIT's Sloan School of Management.

In that interview, Johnson argues forcefully that the United States government should follow the standard IMF formula for dealing with “bad” banks: nationalize them using FDIC intervention, reorganize them, clean them up, and immediately privatize them again.

Paraphrasing what Johnson has written in recent weeks, Terry Gross stated: “If you showed old hands at the International Monetary Fund... the U.S. ledger books, but you hid the name 'United States,' so that they didn't know what country you were talking about, they would all say, 'Nationalize the banking system. That's the solution.'”

Mr. Johnson agreed and in the rest of the interview made a very cogent argument for why such a policy makes the most economic sense as well as warning that the current policy of serial bailouts may only be prolonging the crisis and potentially making it worse.

But Terry Gross also pointed to a central flaw in this “obvious” solution when she drew a distinction between the hypothetical “if you hid the name of the country,” and the reality that this crisis is taking in the world's second largest economy and most powerful nation in the world.

Johnson himself acknowledged the political sensitivity surrounding the crisis when he said that since the United States is the IMF's largest shareholder, that organization doesn't even want to state publicly that U.S. should take the nationalization route.

The resulting paradox is that a temporary nationalization seems to be the sensible, time-tested solution to managing “bad” banks even for a superpower like the U.S. Yet no one dares say so.

Instead, as NPR “Planet Money” reporter Adam Davidson indicated on Morning Edition, “The official word is clear: The Obama administration and Federal Reserve officials say that nationalizing the banks is the wrong choice and that they have no intention of doing it,” (“Obama Administration Could Still Nationalize Banks,” March 6, 2009).

The reasons: 1) Republicans screaming about “socialism” in our banking system, even though the government already owns substantial portions of some of the largest banks like Citibank; 2) Fear that the very mention of the “n-word” will precipitate a run on banks or further devaluation of financial stocks in the stock market; and 3) the fact that many politicians are highly indebted to Wall Street for political contributions and don't want to be in the position of being responsible for their donors losing their jobs.

In fact, Simon Johnson's strongest criticism of the actions the Treasury Department has taken to date focuses on the fact that so many banking executives like Vikram Pandit of Citibank have been allowed to stay in their positions, when a central tenet of cleaning up banks is: First, fire all the top level executives.

However, while the government continues with its official denials of any intentions to “nationalize” failing banks, more and more of those in the financial world expect that behind the scenes, they are taking precisely the kinds of steps that would constitute nationalization in all but name through increasing levels of government ownership of struggling banks.

As one independent analyst, Sean West of Eurasia Group, told Adam Davidson, “The net effect, rather than actually talking in [the] language of nationalization, it's really [that] the government has opened the door to increasing ownership of these banks.” In other words, if the U.S. doesn't dare nationalize the banks openly, it may be setting up “stress tests” that force the banks to ask for such intervention, that is, to “nationalize themselves.”

So even if “nationalization” is the new “n-word” in the political lexicon, the extent of government intervention and government control of banks continues to increase. Taking the standard IMF approach to cleaning up the U.S. banking system may not be politically feasible or even logistically possible since the scale of clean-up required is unlike anything the IMF or FDIC or any regulatory agency have ever seen.

But it seems that whether or not we call it “nationalization,” we the people and our government are ending up owning a lot more of the banking system than we ever bargained for.