"There are four basic approaches to cleaning up a banking system that is facing a systemic crisis: recapitalisation of the banks, together with a purchase of their toxic assets by a government 'bad bank'; recapitalisation, together with government guarantees – after a first loss by the banks – of the toxic assets; private purchase of toxic assets with a government guarantee (the current US government plan); and outright nationalisation (call it or 'government receivership' if you don’t like the dirty N-word) of insolvent banks and their resale to the private sector after being cleaned.
Of the four options, the first three have serious flaws. In the 'bad bank' model, the government may overpay for the bad assets, whose true value is uncertain. Even in the guarantee model there can be such implicit government over-payment (or an over-guarantee that is not properly priced by the fees that the government receives). In the 'bad bank' model, the government has the additional problem of managing all the bad assets that it purchased – a task for which it lacks expertise.
Thus, paradoxically nationalisation may be a more market-friendly solution: it wipes out common and preferred shareholders of clearly insolvent institutions, and possibly unsecured creditors if the insolvency is too large, while providing a fair upside to the tax-payer. It can also resolve the problem of managing banks’ bad assets by reselling most of assets and deposits – with a government guarantee – to new private shareholders after a clean-up of the bad assets.
Nationalisation also resolves the too-big-too-fail problem of banks that are systemically important, and that thus need to be rescued by the government at a high cost to taxpayers. Indeed, the problem has now grown larger, because the current approach has led weak banks to take over even weaker banks. Merging zombie banks is like drunks trying to help each other stand up. JPMorgan’s takeover of Bear Stearns and WaMu; Bank of America’s takeover of Countrywide and Merrill Lynch; and Wells Fargo’s takeover of Wachovia underscore the problem. With nationalisation, the government can break up these financial monstrosities and sell them to private investors as smaller good banks."
Greg Mankiw (!) too finally appears to approve of nationalization, albeit with any other name! He writes, "If this is the route we go down, the government had better get in and out as quickly as possible. If it is done right, nationalization will be the wrong word to describe the process."
More support for nationalization, this time from Andrew Rosenfield, who advocates that in true capitalist spirit, the equity holders who failed their banks should pay for their recklessness and greed and the government should seize insolvent banks and take them into receivership. It should then appoint a new management team and inject equity into them. Steve Levitt agrees.
Roubini again on nationalization - is something the partisans would have regarded as anathema a few weeks ago. But when I and others put it in the context of the Swedish approach [of the 1990s] - i.e. you take banks over, you clean them up, and you sell them in rapid order to the private sector -- it's clear that it's temporary. No one's in favor of a permanent government takeover of the financial system... The idea that government will fork out trillions of dollars to try to rescue financial institutions, and throw more money after bad dollars, is not appealing because then the fiscal cost is much larger. So rather than being seen as something Bolshevik, nationalization is seen as pragmatic. Paradoxically, the proposal is more market-friendly than the alternative of zombie banks".
Mathew Richardson weighs the case for and against nationalization and favors going for it. David Leonhardt too favours it.
Paul Krugman critiques the plan to prop up zombie banks here.
Mark Thoma compares the relative merits of government purchases of toxic assets, Subsidies and Public-Private partnerships to get the market in toxic assets going (Geithner Plan), and nationalization, using the parable of toxic cars market.