Crash of 2008

In a post entitled "Mitch McConnell Gets It Right", Erick Erickson at RedState quotes Sen. McConnell:

I think nationalizing the banks is an absolutely wrong thing to do.

Erickson then comments:

Citibank does not need nationalization. It needs bankruptcy. Just because it has a bunch of foreign investors does not mean it should get out of the process a lesser entity would go through.

Can anyone tell me the point of this line of argument? I have no doubt that both Erickson and McConnell understand that nationalization or receivership is bankruptcy for banks. When he calls for Citibank to receive the same treatment a lesser entity would receive, is Erickson not calling for Citibank to be treated like IndyMac? And yet with the next breath he rules out the very process with which IndyMac was treated: nationalization.

By posing the false choice between bankruptcy and nationalization McConnell and Erickson effectively give Schumer, Geithner and Obama cover to service Democrat big donors at the expense of the taxpayer. How does this position benefit taxpayers, conservatives or the GOP?

Why are we throwing away the single best opportunity to demonstrate fiscal responsibility, financial credibility, political courage and most importantly relevance? All the while pushing the hands-down consensus best policy.

I'm really at a loss on this. What a coup it would be for the GOP to have economists from the right of Martin Feldstein all the way to Paul Krugman lining up to praise our leadership on this! But it's not going to happen.

Erickson and McConnell understand that IndyMac was nationalized. They understand it is very likely that Citibank is insolvent. Why then do they demure from leading on this?

If we are passing on this golden opportunity merely from fear of the term "nationalization" then we have lost faith in our ability to manage our message effectively. Let's call it pre-privatization, let's call it receivership, hell, let's call it bankruptcy. But whatever we do, let's call for it before the opportunity is lost.

By coddling their Wall Street friends and benefactors the Obama Administration is engaging in a form of crony capitalism. The GOP can do the country, the economy and themselves a service by bringing political pressure to bear by vigorously supporting calls for bank nationalization.

As a follow up to my initial post recommending the GOP embrace bank nationalization, let me draw your attention a post by Greg Mankiw former head of the Council of Economic Advisors under President Bush and a professor of economics at Harvard. Mankiw provides a useful corrective to the initial shock of the term "bank nationalization" by spelling out what it would actually mean and how it can relatively painlessly provide a solution to the banking/credit piece of the economic crisis. He begins by discussing why the idea puts people off.

Why are people scared about the idea of nationalization? One reason is that it is a sign of the depth of our problems. A second, more substantive reason is that it seems to point in a bad direction. I certainly do not want the government deciding who deserves credit and who does not, what kind of investments are worthy of financing and what kind are not. That is a big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.

Let me interject here that Geithner and Obama are themselves engaged in a form of crony capitalism because they are working hard to protect the claims of their insolvent Wall Street supporters. Mankiw continues:

If the government is to intervene in a big way to fix the banking system, "nationalization" is the wrong word because it suggests the wrong endgame...the goal should be a massive reorganization of these financial institutions. Some might call it nationalization, but more accurately it would be a type of bankruptcy procedure.

Bankruptcy could become, in effect, a massive bank recapitalization. Essentially, the equity holders are told, "Go away, you have been zeroed out." The debt holders are told, "Congratulations, you are the new equity holders." Suddenly, these financial organizations have a lot more equity capital and not a shred of debt! And all done without a penny of taxpayer money!

By declining to perform their regulatory mandate, the Fed and other regulators are allowing insolvent banks to pretend they are solvent at the cost of paralysing the crucial financial intermediation services the banking sector provides to the larger economy. That effectively means the government is trying to pick the winners in this fight which is both a very bad idea and a form of crony capitalism.

As I suggested in my original post on nationalization, this presents the GOP with a rare opportunity where the minority party can differentiate itself by saying yes and championing the right policy rather than always being in the position of having to say no to the majority's initiatives. The Democrats lack the political will to do what they know is the correct policy. The GOP can demonstrate seriousness, leadership and gravitas by pushing the majority to do what everyone knows is the right thing.

In his post Demanding Results from the Stimulus, Patrick advocates a tactic of holding Obama accountable for his promise that the stimulus would create or save 4 million jobs. That's all well and good as far as it goes, but as tactical politics it risks three mistakes. First, how are you really going to measure it? Second, it is entirely reactive; Obama and the Congressional Democrats set the agenda and the GOP "holds them accountable". Third, at the pace the crisis is developing, the stimulus package will be overtaken by events in the next 3-6 months. Remember back in September when the $85bn we paid to acquire AIG seemed like a lot of money? $800bn is going to seem as insignificant in the next 6 months. For example, one among a thousand, Switzerland, that paragon of financial stability and safety, may go the way of Iceland.

Reform of the banking system presents a huge opportunity for the GOP to seize the initiative in dealing with the economic crisis and in so doing put genuine political pressure on the Obama Administration. The GOP should call for nationalization of the insolvent U.S. money center banks.

Many economists and financial policy makers now believe that some, perhaps the majority, of American money center banks are insolvent. The Financial Times quotes former Fed Chairman Alan Greenspan:

It may be necessary to temporarily nationalise some banks in order to facilitate a swift and orderly restructuring...I understand that once in a hundred years this is what you do.

The rational and responsible way to deal with the situation is quickly to take those banks over, write-down the losses and restructure their remaining capital so that they can get back to the business of providing financial intermediation to the American and global economies. Once they are stable they can be sold to new investors.

Unfortunately, as a nation we currently lack the political will to do this. The bankers are reluctant to admit their situation and realize their losses. Politicians of all stripes are beholden to Wall Street for past support and fear the implication of the term "nationalization". But the fact remains: a significant segment of US banking is insolvent. Until they are forced to recognize their losses the big banks hold American capitalism hostage to their failure. Without banking reform an essential prerequisite to economic recovery is missing. Whatever form economic recovery takes, public spending stimulus or private enterprise, it will be hobbled without a sound banking sector. For this reason banking reform will get done however inefficiently. Geithner's "stress test" is designed to identify the insolvent banks with minimum political risk and minimum sacrifice by the bankers.

The GOP has an historic opportunity to provide the political will to push for what everyone recognizes is necessary. It is a "Nixon goes to China" moment, if you will. By seizing the initiative while others fiddle and calling for reform and restructuring of the American banking system, three huge advantages would accrue to the GOP:

1. On the merits, we will be advocating the right policy and thereby we will build trust and credibility with the American people.  
2. Forcing the bankers to bear their own losses is smart, fair and popular. By advocating the right policy and advocating prompt action, the GOP can reassert our economic bona fides while at the same time serving the interests of the US taxpayer and do so in a way that is easy for the taxpayer/voter to understand. 
3. By coming out forcefully for nationalization the GOP will bring real political pressure to bear on the Obama Administration and the Democratic Congress who are still beholden to their Wall Street masters.

I recognize that this proposal goes against the grain of modern conservative thinking in at least two ways.

First, it takes the banking crisis very seriously indeed and accepts that serious measures will be required to work it out. I do not believe a laissez-faire solution is in the best interests of the American people, the American economy or the Republican Party.

Second, it takes the view that government has an important and even an essential role to play in reforming the banking system.

I know that many conservatives will strongly disagree with me on these two points. Nevertheless, I believe that the policy is correct and that the opportunity is remarkable.

Thanks for listening.

If the discussion of the range of responses to the banking crisis on This Week today is any indication, we are truly living in a topsy-turvy world.

Stephanopolous leads with a clip of President Obama addressing a question about the nationalization approach taken by Sweden to resolve a mortgage bubble driven financial crisis in 1991-1992.

Barack Obama:

Sweden has a different set of cultures in terms of how the government relates to markets. And America's different. We want to retain a strong sense of private capital fulfilling the core investment needs of this country.

Lindsey Graham:

I think if you put most of our major banks under a 'stress test,' they're going to fail...

This idea of nationalizing bank is not comfortable but I think we have got so many toxic assets spread throughout the banking and financial community throughout the world that we're going to have to do something that no one ever envisioned a year ago, no one likes.   

To me banking and housing are the root cause of this problem. Government is going to have to...I would not take off [the table] the idea of nationalizing the banks.

Chuck Schumer:

I would not be for nationalizing. I think government's not good at making these decisions as to who gets loans, how this happens...

GOP Rep. Peter King joined Sen. Graham in speaking in favor of nationalizing some banks. Only Rep. Maxine Waters remained true to form. She, of course, has no fear of a government-based solution.

Needless to say, Schumer's remarks are disingenuous in the extreme. First, no one is talking about the government running the banks long-term and making "decisions as to who get loans", etc. Nationalization is merely a mechanism for an orderly disentanglement of failed banks, not dissimilar except in scale from what the FDIC does regularly. Second, Sen Schumer as usual neglects to mention that he is wholly a creature of the New York financial services industry. Schumer's opposition to nationalization is completely self-serving since step one of nationalization would be to wipeout the shareholders (his campaign contributors) and fire the executives (his friends) of any bank found to be insolvent.

On a purely partisan basis bankrupting Schumer's financial base would be good for the GOP since Schumer's ability to bring Wall Street money to the Democratic Party is a major if under publicized reason for his party's resurgence.

As a matter of policy, I agree with Sen. Graham that some of our major banks are indeed insolvent; their liabilities exceed their assets. It is only by clinging to the fiction that the face value of their toxic assets have any bearing on reality that these institutions can present a balance sheet that is not dripping red ink. As long as they insist on carrying on with that charade they will not have real assets to lend and that will mean the American economy will lack a robust financial intermediation function.

So here we are in a topsy-turvy world where within days of passing the gargantuan stimulus bill Democrats are lining up to preserve the zombie banks and Republicans are calling however modestly at this point for their nationalization. What a world!