William K. Tabb on The Road Not Traveled—Nationalization
“The White House, whether under the management of Republicans or Democrats, was never ready for such a business-like approach. Ironically the abuse the administration would take for being ‘socialist’ would keep any chief executive from considering a protaxpayer, hardheaded business approach to banking.”—William K. Tabb on the possibility of adopting the “Swedish solution” for bailing out U.S. banks.
In chapter six of The Restructuring of Capitalism in Our Time, William Tabb explores some of the responses to the Great Recession and what the Bush and Obama administrations did and did not do. In this section, Tabb explores the option of nationalization:
The Road Not Traveled—Nationalization
Prominent economists expressed skepticism over the bailouts, including Joseph Stiglitz, a former chair of President Clinton’s Council of Economic Advisers; Paul Krugman, Princeton professor and New York Times columnist and, like Stiglitz, a Nobel Prize winner in economics; and Simon Johnson, MIT professor and former chief economist at the International Monetary Fund. In an essay titled “The Quiet Coup,” Johnson (2009a) suggested that the finance industry has captured the government of the United States and continues to guide its rescue efforts in its own interests and not those of the country. From an international regulator’s perspective, it all looked familiar. He describes what he calls “a classic Kremlin bailout technique,” the assumption of private debt obligations by the government, which acts to squeeze ordinary citizens and make taxpayers and service recipients bear the cost of financial-sector debt. That is to say, the ruling class of the United States and its dominant fraction, finance capital, manipulates government policy in much the same way the Kremlin or a rent-capturing elite of any global South debtor country might. In this view American crony capitalism reflects the collusive relation of the financiers, their regulators, and elected officials. Johnson writes, “If you hide the name of the country and just show the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.”
As an alternative to bailing out the banks, there was early in the financial meltdown much talk of the Swedish way of resolution, which wiped out stockholders, put toxic assets in a “bad bank” and sold them off over time, and reprivatized the good banks following their reorganization. Rather than strengthening the banks as they had existed, the Swedish fix nationalized banks and restructured them. This was carried out by the conservative center-right coalition in power in Sweden at the time, market-oriented officials who nationalized the banks to save the taxpayers money. The government imposed strict guidelines on companies receiving public assistance, including risk management and cost cutting. Swedish regulators hired qualified real estate people to sell off the assets and maximize taxpayer returns on their investment. The Swedes early offered blanket guarantees to any investor holding bank liabilities (except, importantly, stock and subordinate debt holders). They did not take a piecemeal approach but were decisive and clear in their actions. Of course they had only five large banks to worry about. Still, the lesson, as explained by the Swedish finance minister responsible for bank restructuring, Arne Berggren, was that the government was a commercial investor: “We were a no-bullshit investor—we were very brutal.” The authorities took control. “You take command. If you put in equity, you have to get into management of the business, [otherwise] management is focused on saving the skins of the [remaining private] shareholders” (Larsen and Giles 2009:7). They ran the banks with transparency to keep the trust of the public and markets. They refused to buy assets from privately owned banks because officials said it would have been impossible to agree on a price, and they were not in the business of giving privately held banks subsidies. Real capitalists, the message seemed to be, nationalized.
Interestingly, respected elders of an earlier Republican Party (as opposed to the “just say no to anything the Democrats propose” party), from an era in which some form of bipartisan statesmanship was possible, endorsed the general outline of the Swedish solution. James A. Baker III, chief of staff and treasury secretary for President Reagan, and former Fed chair Alan Greenspan, among others, proposed nationalization of failed banks. Baker pointed to Japan’s lost decade (1991–2002) when it held up its zombie banks, postponing recovery. While he “abhorred” the idea of government ownership and invoked the sainted memory of Ronald Reagan to this effect, he urged consideration of something akin to the Resolution Trust Corporation to liquidate the bad assets of the banks (as the RTC created in 1989 did for the failed Savings and Loans). Baker, Greenspan, and others did not see a good outcome from reinflating a finance-driven bubble economy. Experience in a multitude of other countries suggests that providing massive liquidity and open-ended guarantees to insolvent institutions (and in effect resurrecting a number, perhaps a very large number, of them) distorts risk-taking incentives and, by undermining market discipline, promotes future crises (Calomiris, Klingebiel, and Laeven 2005). Such research finds even the short-run benefits of bailouts oversold. They increase the cost of resolving the crisis and prolong it (Honohan and Klingebiel 2003).
American banks could have been divided into three groups: the healthy, the hopeless, and the needy. The first group was left alone, the second closed down quickly, and the third was reorganized and recapitalized, preferably through debt-to-equity swaps, but if necessary through equity investment at the market price of the stock. Shareholders would lose their investment and bondholders would take a haircut (partial losses). Such a program would give banks in the future incentive not to risk such a fate. Barack Obama commented favorably on the success of the Swedish nationalization, but he quickly followed this evaluation with a remark about the different cultures of the two countries, making it clear that such a solution, in his view, was simply not possible in the American context.
The White House, whether under the management of Republicans or Democrats, was never ready for such a business-like approach. Ironically the abuse the administration would take for being “socialist” would keep any chief executive from considering a protaxpayer, hardheaded business approach to banking. In its defense, the U.S. banking system was so much larger than Sweden’s and the interconnections such that it would have been a substantially more complex operation, leading to a “radical overhaul” of the global financial system, as Vikram Pandit, Citigroup’s CEO, said (Guerrera 2009:17). Pandit preferred more taxpayer money and, at a point at which Citigroup’s stock was selling at less than a dollar a share, asked that the government buy 40 percent of the bank (with of course no more interference than when the government owned half as much of the company).
Despite shows of populist rhetoric on occasion from the White House, the country was not ready for the scale of government takeover that would have been necessary to nationalize banks as the Swedes and others had done. In 2010 the Democrats were to lose control of the House of Representatives, badly bruised by voter sentiment that the Obama administration had done too much and that liberals had led a Big Government takeover, even though the president had actually interfered in the market as little as he could have without failing to meet minimal obligations to return the economy to some semblance of normality. The White House, in responding to the crisis, faced a series of decisions in which there were not good choices, only less bad ones. The president and his advisers may not have always been right, but the public anger at not quickly repairing the economy and reducing joblessness was understandable, even if it was unreasonable. After a major financial crash there is usually a long period of slow growth and high unemployment unless the government intervenes on a scale the public is generally unwilling to contemplate. Had the president come in, as FDR did, after three terrible years of greater recession/depression, he would have had more room to maneuver. As it was, the president was criticized both for doing too much and for doing too little, often by the same angry people.
By late 2009 the three largest American banks—Bank of America, JPMorgan Chase, and Wells Fargo—had become the overwhelmingly dominant providers of financial services of all sorts. The three together controlled a third of the nation’s deposits. Two years earlier, the top three banks had only 20 percent of the industry total. The thought that the survival of Bank of America (16 percent of GDP) or Citigroup (13 percent of GDP), which had not so long ago been in serious question, had been restored and strengthened through government action could be seen as a reward for the damage they had caused. Because larger banks had absorbed weaker and failing ones, the industry had become more concentrated. In 1997 the six dominant banks had assets equal to 20 percent of the country’s GDP; in 2009, an amount equal to about two-thirds of the nation’s GDP. They were too big to be allowed to fail, making any living will that they developed unlikely to be implemented.
The size of the burden of rescuing the financial sector would not be known for some time. One of the major worries was the nonperforming loans held by Fannie Mae and Freddie Mac. From September 2008, when the government seized the companies, to September 2010, the cost of keeping them functioning rose by over $150 billion as Washington took responsibility for homes in foreclosure that had once been the responsibility of the private financial sector. It was paying $1 billion a year to mow the lawns on these properties and for other maintenance. Some of the same real estate firms that had initially sold the foreclosed properties were hired by the agencies to resell them. Since prices had fallen so much, Fannie and Freddie were recouping less than 60 percent of the money borrowers had failed to repay. Their contingent liabilities were huge. According to the Congressional Budget Office, likely losses in the summer of 2010 amounted to $1 trillion out of the $5.5 trillion in mortgages and loan guarantees Fannie and Freddie had acquired. The eventual total was likely to go higher. Rahm Emanuel, the White House chief of staff (and a former investment banker and Freddie Mac board member), said that the resolution of these institutions would have to wait. (When Emanuel resigned his post to run for mayor of Chicago, he was replaced by William Daley, vice chairman of JPMorgan Chase.) Confronting the extent of Fannie and Freddie’s losses would dramatically increase the federal deficit. The Obama administration did not want to fully nationalize them, nor could they be sold, given their debt. Treasury Secretary Geithner would only say that some day in the future the companies “will not exist in the same form as they did in the past.” Meanwhile they would go on bailing out the banks and offering life support to the housing market. Without the buying by them and the FHA of 95 percent of all new mortgages, the housing market would be dead in the water.
While Washington’s focus was on what to do about Freddie and Fannie, the extent of bank malfeasance exposed grew. As the first decade of the twenty-first century wound down, there were a number of court cases against the large international banks. The Guardia di Finanza, the Italian financial police, took over the real estate property, accounts, and stockholding of JPMorgan Chase, UBS, Deutsche Bank, and others in a case involving issues of local government bonds over the decade (about $46 billion worth) and the losses by sustained following the advice on derivatives by bankers. The deals were complicated, but the failed promise of a safe way to reduce the cost of long-term debt is familiar enough. The investment bankers, it appeared, had taken advantage of unsophisticated local officials, and local taxpayers suffered great losses as a result. J.P. Morgan Securities forfeited hundreds of millions of dollars in derivative contract fees in a settlement with an Alabama county (with, as usual in such cases, neither admitting nor denying any of the government’s accusations). It seems its employees had bribed county commissioners to win the business, which turned out poorly for the county when absolutely safe investments turned into unbearable losses, burdening taxpayers. Calpers, the California Public Employees Retirement System, was embarrassed by a former board member who made $50 million in “fees” for arranging investments that could cost the already strapped state hundreds of millions of dollars.
Hapless Citigroup was caught by the Financial Industry Regulatory Authority (which oversees broker-dealers) and fined $600,000 for using complex derivatives to help offshore clients avoid billions of dollars in taxes. Its imaginative products included total return swaps, which involved customers selling stockholdings to the bank during periods when dividends were paid (for which they would receive income from the bank equal to the dividend and any appreciation in the value of the stock). Citi, again as usual, was allowed to neither admit nor deny wrongdoing. A year later, in the summer of 2010, Citigroup agreed to pay $75 million to settle SEC charges that it failed to disclose more than $40 billion in exposure to subprime mortgages to its investors. Its former chief investment officer and former investor relations director agreed to pay personal fines of $100,000 and $80,000, respectively, for drafting and approving misleading statements at a time when investors were hanging on every word from the bank as to what the losses might be from toxic bank holdings. When these were later revealed, they cost former CEO Charles Prince his job in November 2007. Citi eventually lost $30 billion on the assets and required more government support than any other bank. It was not alone in obscuring its holdings to investors. Such instances touch the sort of morally questionable and illegal practices of the period, which, for the most part, governments were not interested in delving into too deeply while they were rescuing these same firms from their own mistakes and dishonest dealings. Critics considered the SEC charge of unintentional fraud to be relatively minor given what Citigroup and others had done.