Six months ago, the idea of nationalizing banks was preposterous except to the craziest economists.  Three months ago, I was sure it was a bad idea.  Today, hell I don’t know.

When a government nationalizes a company or industry, they take over control of the company.  Profits or losses are now essentially the burden of taxpayers.  Oppressive governments might nationalize a highly profitable industry, like oil drilling and refining; and conversely a capitalistic government would nationalize an industry in trouble, restoring the much desired confidence in the system.  The bank nationalization we’re discussing is the latter.

Let’s look at a case against nationalization, then a case for it.

We Shouldn’t
When a government takes control of a company, current shareholders will lose value.  If you own stock in Bank of America, and it is nationalized, you might get pennies per share of each stock you own.  Just about everyone in the country owns shares of BofA, directly or indirectly (mutual and pension funds) so taking control of the bank will reduce the overall wealth of the entire country.  This would have the opposite effect of restoring confidence in the system.

If you’re a bank, you likely own the preferred shares and bonds of a competing bank.  This has been done for many years and helps contribute to (what was) the stability of the financial system.  When you nationalize a bank, all the other banks will lose value.  If they lose value they must up their cash reserves to support for the losses.  More cash in reserve means less loans.  Less loans once again hurts the economy further.

On top of owning various liabilities and equities of other banks, competing banks also lend to eachother.  The interbank loan rates are established most often with the LIBOR average as a base rate.  With some banks nationalized and others private, the nationalized banks will get preferential treatment.  This will mean the private banks can’t loan money at a rate lower than their nationalized competition.  Without the ability to lend to eachother, the private banks will go out of business, further hurting the confidence of the financial sector.

We Should
The whole point of nationalization of the banks is to provide the confidence needed to restore the lending markets.  The government is already backing the loans of the top institutions, they already are invested in them too.  So in essence, the American taxpayer is already responsible for the profits and losses of the companies we are backing.  Nationalization will merely just be the next step.

With the government directly in control of the banks, we can now freeze salaries and bonuses.  All divisions that engage in risky lending or investing could be dissolved.  Imagine a box of chocolates.  The maker of the box (the bank executives) loves all the pieces equally and doesn’t want to remove the bad ones.  The government could come in and force them to removed all those nasty coconut pieces.  The company would now not have the expense of producing those pieces and the end user won’t have to bite into each piece to find the gross ones.

Up until now, the bondholders of the banks haven’t suffered the same losses of other investors.  The economy is in the tank and those funds and companies that invested heavily in bank bonds haven’t had to bear any of the risk the rest of us had.  Nationalizing the banks will force them to accept some losses.  Think of this like the UAW refusing to make concessions with GM.  The government basically forced the UAW to make concessions.

This isn’t every argument for and against bank nationalization, just merely what comes to my mind when I have my internal Oxford Style Debates.  My thinking right now is I still don’t want the banks nationalized, because I fear it will create too much short term instability to make a long term plan viable.  I’m open for being swayed though, so for the politicians supporting it, let’s see what you go.

Do you have an argument for or against nationalization?  It could mean the end of $40 overdraft charges, but it could mean the end of cashback rewards too.

Image Credit: Steve Rhodes
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categories: banking, economics, government