Tuesday, January 20, 2009

Stop mucking around!

14:30 GMT +00:00
January 20, 2009
Economist.com, free exchange blog

As troubles in the banking industry have moved back into the limelight, the need for a broader, and more effective solution has again become clear. While the use of the initial TARP allotment has prevented any immediate collapse, it seems clear that fears of insolvency (and actual insolvency) are going to remain a problem. Some banks will be forced to return to the trough repeatedly, and lending, in general, will remain moribund.

Last week, Ben Bernanke gave his menu of options to the incoming Obama administration . They had the look and the promise of warmed up leftovers. The purchase of troubled assets was on there, as was loan guarantees and equity injections, and the creation of a massive government "bad bank". Not really on the list was nationalisation.

But it seems to me, based on an ongoing blogospheric discussion, that nationalisation is the only good option left. The basic problem is this—some banks are likely insolvent. Any option that solves the problem by buying bad assets will either fail (if those assets are bought at face value—recall, the banks are insolvent) or will succeed by buying those assets at well more than they're worth. The latter option is a large and generous gift to the bank's shareholders.

The question is, why would one want to give a large and generous gift to bank shareholders, out of the taxpayer's purse? And the answer most commonly given seems to be, "to avoid nationalisation". But why? One concern seems to be that the practice isn't particularly liberal or "American". But from a purist's standpoint, neither is the cutting of billions of dollars' in cheques to insolvent banks. Another concern may be the problem of whether the government can manage banks effectively. But of course, the current ownership has already failed miserably, to the point that taxpayer money is necessary to prevent a devastating collapse.

These banks grew so large that their faliure threatened the global financial system, and then proceeded to fail. To simply hand over the money necessary to return them to solvency would abuse the taxpayer's trust, reward bad behaviour, and send a terrible signal to other bad financial actors out there. Time to quit mucking around and make with the nationalisations.

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