The Bonanza

Read Josh Marshall and Paul Krugman on the back-from-the-dead idea that what we need is for the government to spend hundreds of billions of dollars buying up “toxic assets” from banks and then setting up a “bad bank” to warehouse the assets and try to sell them off down the road for whatever they’re worth.

In terms of how this should work, it’s actually a close cousin to my preferred solution of nationalization. Under nationalization, you take a “too big to fail” bank whose equity value has plummeted because of problems with its balance sheet, wipe out the shareholders, and nationalize the enterprise. Then you hive off the “toxic assets” from the rest of the enterprise. You then may or may not do such things as fire top managers, put people on the GS salary scale, and force banks to operate in the public interest by lending. But the point being that you do this to some number of banks that are in serious distress. Then when there’s some measure of recovery in the economy you start re-privatizing the “good” banks and selling off the assets owned by the “bad bank” for whatever you can get for them.

Both approaches involve the taxpayers eating a substantial loss on the value of the toxic assets—there’s simply no way around that. But under a TARP scheme, the loss eaten becomes a gift to the equity stakeholders in the existing banks. Under a nationalization scheme, there is no such gift and the public cost should be lower because you get to sell off not only the toxic assets but also the “good bank” that results from the cleanup. What’s more, under a TARP scheme every bank that bought bad assets gets a gift. Under a nationalization scheme, the people who own banks really really really really really really won’t want their bank to be nationalized. Which is at it should be. The free market is good and we shouldn’t have the government running every bank under the sun. But that means that nationalization, and the resulting need for taxpayers to eat the losses on the toxic assets, will only be done to banks that are desperately in need of assistance much as the FDIC’s existing mechanism for bank failure only kicks in if the bank is actually going to fail not just if it made a bad business decision.

The TARP alternative is somewhat better for bank managers, much better for equity stakeholders in banks, much better for preserving the myths of American capitalist ideology. Nationalization would be better for ordinary citizens.