I think Felix Salmon and Tim Fernholz are both unduly impressed by the arguments presented in Ryan Lizza’s Larry Summers profile as to why the administration was right to reject bank nationalization as a financial crisis-management effort. Here’s what Lizza reconstructs:
The memo was divided into four sections. First, Summers explained that there was no legal authority to take over large bank-holding companies like Bank of America and Citigroup. Next, he pointed out that full nationalization of a financial institution might trigger systemic shocks, as investors retreated from other banks, creating exactly the kind of panic that nationalization was intended to prevent. (As [Obama economic official Gene] Sperling often argued, “You might come out and say, ‘I’m gonna take over Bank of America and Wells Fargo, but everybody else is safe!’ Maybe they believe you. And maybe they don’t. But if you get this wrong the Dow’s at thirty-five hundred! You’re the worst economic manager in the history of the United States!”)
Furthermore, Summers said, there was a medium-term risk that nationalized banks would lose value, in the same way that the act of foreclosure decreases the value of a home. Summers pointed to the example of Sweden, which was regularly cited by economists who favored nationalization. But Summers noted that Sweden didn’t nationalize for two and a half years, by which time the situation had become so severe—interest rates had reached a hundred per cent—that there were no other options. In addition, Nordbanken, the largest bank nationalized in Sweden, was already eighty per cent government-owned. Summers concluded by emphasizing that nationalization was a strategy that governments turn to only after it is very clear that nothing else can work.
The results of the stress tests showed that the banks were not in as dire shape as commonly believed. Most of the nineteen banks were able raise money privately. “It worked,” the Treasury official said. “People had money to put into banks. The nationalization crowd would have had the government putting all that money in.”
The key thing here is that the arguments as being relayed to Lizza seem not to know that the proposal to apply the Swedish model to the banking sector was a proposal to nationalize insolvent banks and explicitly guarantee the debts of the solvent ones. This is precisely designed to deal with the “nationalization sets off larger panic” worry. The fact that the stress tests showed that many banks were not in such bad shape is also irrelevant. Nobody ever proposed that we nationalize banks that weren’t in trouble. The proposal was to guarantee the obligations of banks that weren’t in trouble, a low-cost move since these are the banks that aren’t in trouble. The Obama administration wound up implicitly doing that anyway, which is precisely why most of the banks were able to raise money privately. The exact same thing would have played out with the exact same banks if the troubled banks had been nationalized.
The last resort argument seems frivolous to me. Yes, Sweden did this as a last resort. And it worked. Which is why it was being suggested that we not wait through a grinding two-and-half-year financial crisis before employing the remedy. I don’t think Summers took from the 1929-1940 experience that the correct thing to do is wait through 11 years of Depression before stimulating aggregate demand.
The legal authority question, by contrast, is obviously a real concern. If there’s no legal way to do something, then you can’t do it. But by the same token, if lack of explicit legal authority was really the objection to the policy, then you’d be writing a memo about (a) options to get the authority, (b) options to do it without explicit authority, and (c) alternatives to nationalization. Instead, we got a memo in which lack of explicit legal authority was thrown in as part of the kitchen sink.
To me the whole thing looks political. If you’re going to do something that’ll get you tagged as having undertaken an unpopular “bank bailout” then you might as well do it in a way that makes the bankers happy. Nationalization sounds at first glance like a sunny populist solution, but it would have still been hugely expensive and still characterized by many as a “bailout” (and, indeed, the whole point is in fact to bail out the creditors of major financial institutions) and also gotten Obama tagged as a Communist. You can’t take the politics out of politics, so on one level I say so be it. But on another level you still do have to worry if the handling of this crisis has paved the foundation for the next crisis.
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