Arms-length nationalization or bankruptcy?

After the initial opposition and debate, the voices supporting nationalization are getting louder. The latest to join in support is Alan Greenspan, once an ardent supporter of the fiction that modern financial markets are self-correcting.

Even some of the shrillest initial opponents of nationalization are now switching sides, albeit grudgingly and with some semantical gymnastics. Alex Tabarrok of Marginal Revolution feels that nationalization may now be "very likely" and even "desirable", but prefers to use the term "bankruptcy" instead to describe the process. He argues for a bankruptcy takeover wherein the "government steps in, removes current management, pays off the depositors, reorganizes and then sells the banks to recoup its losses". This, he says, is the capitalist solution to bank failure, since the presence of deposit insurance effectively makes government the guarantor of all the liabilities of a bank and a government takeover would be the capitalist way to punish the owners of the failed banks.

Andrew Rosenfield draws attention to the crucial distinction between a normal firm and a bank, "Banks are rather special firms; they are so highly leveraged that their operations heighten the possibility of contagion and "systemic" risk. As a result, the government itself provides insurance against imperilment and failure to certain investors - depositors and buyers of special debt instruments called certificates of deposit issued directly by a bank (but not the debt issued by a bank holding company) to prevent runs and build trust. In return, banks are not subject to the general bankruptcy statute. Instead, the government enjoys special contractual control rights that allow it to simply and swiftly take over banks it regulates whenever they become imperiled. Those rights include "receivership," which gives the government license to treat bank failures economically and expeditiously."

Both Rosenfield and Tabarrok make the case for separating ownership from day-to-day management of the banks so taken over. They write that the government should install a new CEO of its choice, along with senior executive management, then provide the bank with fresh financial capital, and let it undergo the required restructuring process. They also feel that this arms-length takeover and management should preferably be done through the FDIC.

In any case, whether it be bankruptcy or arms-length nationalization, the result is same - government takes over the institution, seizes all assets, removes the existing management, restructures it and then runs it for some time before exiting its stake.

Update 1
James Baker feels that America may be following Japan's unsuccessfull example of trying to keep "zombie banks" on life support, and thereby risk losing a "lost decade". He therefore prefers nation alization in another name - "a temporary injection of public funds to clean up problem banks and return them to private ownership as soon as possible"!

He suggests that all banks be subjected to stress tests under the worst case scenarios and then divided into three groups - the healthy, the hopeless and the needy. Leave the healthy alone and quickly close the hopeless. The needy should be reorganised and recapitalised, preferably through private investment or debt-to-equity swaps but, if necessary, through public funds.

He writes, "The government should hold equity no longer than necessary to restructure the banks, resume normal lending and recoup at least a portion of taxpayer investment. After replacing bank management with new private managers, the government should have no say in banks’ day-to-day operations."

He also feels that the FDIC or an institution like the Resolution Trust Corporation can manage the transition. And all the decisions should be taken in one go, so as to avoid bank runs.