Government Ownership of Banks: A Really Bad Idea
The semi-nationalization of the banking sector resulting from the bailout is a dangerous thing.
The more important issue is whether it is a good idea for the government to own private companies. The answer is no. The bailout is a bad idea in general and the semi-nationalization of the banking sector in particular is a dangerous idea. There are at least three significant red flags:
- Political interference: One of the great advantages of free markets is that resources are allocated based on what creates wealth rather than on the basis of what buys votes. This is why America, for instance, is so much more prosperous than France. The bailout/semi-nationalization puts the financial sector at risk of manipulation by the political class. The Treasury Department is structuring the bailout to minimize this risk, but Congress almost surely will want to expand government control of the industry next year, and the possibility of being able to steer loans and investments will be a great temptation. Indeed, Senator Schumer of New York already is agitating for influence over how capital is allocated.
- Influence peddling: Every time politicians gain more power, the relative power and wealth of the lobbying community increases. This, in turn, increases the extent to which resources are misallocated as various groups (taxpayers, businesses, unions, etc) devote time and energy to influencing government rather than focusing on more productive endeavors. The expansion of government power — especially the government ownership of banks — will attract lobbyists in the same way that picnics attract ants. Some lobbying firm already are advertising their ability to help clients get their hands on taxpayer money.
- Rewarding incompetence: One of the most perverse aspects of partial nationalization is that institutions with careless shareholders and incompetent executives are being given a new lease on life. One of the many advantages of a free market is that people earn profits if they make wise decisions, but they suffer losses if they make poor ones. Government intervention is preventing market discipline from working. This is bad in the short run and may be even more damaging in the long run by creating moral hazard, which occurs when people have a perverse incentive to engage in imprudent behavior.
To avoid the aforementioned risks, Congress should have said no to any kind of bailout. And if they thought some action was necessary, policy makers should have looked at other alternatives. While there is no silver-bullet solution that unwinds the damage of a bubble, a preferable option would have been to close down the insolvent institutions and use taxpayer money to merge those companies with banks that behaved responsibly. For example, the government could give a healthy company, say, $1 billion to absorb a bankrupt firm that is $1 billion in the hole. This is largely what happened during the Savings & Loan bailout and it is what happened earlier this year with Washington Mutual and Wachovia.
The benefit of this approach — at least compared to the semi-nationalization scheme — is that politicians do not become owners of banks or other financial institutions, and careless shareholders and executives learn a much-needed lesson about imprudent risk. Unfortunately, but not surprisingly, the Washington establishment is going with an approach that increases the power of the Washington establishment.
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Dan Mitchell is a senior fellow at the Cato Institute and co-author of Global Tax Revolution: The Rise of Tax Competition and the Battle to Defend It
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15 Comments
1. skink:so your solution is for the Government to give taxpayers’ money to the banks with no return on that money?
no equity, no debt repayment, no interest?
no oversight?
just give it away?
I’m glad you are not looking after my money
Oct 20, 2008 - 1:23 am 2. mjk:My solution would be no bailout, no money, no rescue. Let’s the chips fall where they may.
These banks deserve to fail and unfortunately, so do all the people with the bad mortgages.
The gov’t bailing them out will make our own situation much, much worse. Or will not change it at all.
Oct 20, 2008 - 5:23 am 3. David Wynn:Daniel,
I’d like to take your 3 points against the liquidity injection in turn.
1) I believe this is your weakest point, because you make several statements which blindly ignore what forces have put us in this situation. Assertions such as “One of the great advantages of free markets is that resources are allocated based on what creates wealth” ignores the very idea of bubbles, let alone the current interconnected, overpriced, and undervalued crisis we find ourselves in today. Investors, combined with a lack of transparency regulation, put us here. There seems to be little virtue in giving them a higher standing than the government in this case.
That said, I would also be concerned about the government attempting to direct capital flows once they’ve injected liquidity into banks. Hopefully they’ll be able to take a quiet return on their money and leave once they’ve recouped their losses.
2) I like this point. Influence peddling is a tough nut to crack, but we’ve done an exceptionally poor job of “starving the beast” in the past. I agree that the power of lobbyists would expand here, but I think it should probably be dealt with at a more direct level than avoiding the liquidity injection.
3) This is your most contradictory point. Investors know that when the government buys shares of companies (such as AIG) the shareholders tend to get wiped out. You noted that the market has been unstable since the announcement of the bailout plan, but you seem unwilling to make the link between their reaction adn their likely losses, instead implicitly claiming that investors are looking at the future of government mismanagement of banks. Investors have become increasingly focused on short term returns, which was a major factor in bringing us to where we are today as well as the present financial instability. To read the situation otherwise is to misunderstand what drives market volatility.
Of course, moral hazard is a real and dangerous risk, but I do not believe banks will be securitizing and lending loosely with the confidence that the government will come rescue them with an injection. Instead they appear to be lending to hardly anyone… far the opposite of the expected moral hazard reaction. Again, the concern is real, but I believe in this case it is not a particularly great one.
In short, I think your argument would hold if your assumptions were more solid and more likely, but at present I remain unconvinced that the stock purchase plan is such a bad idea.
Oct 20, 2008 - 5:45 am 4. Brian Richard Allen:“Bailout,” my arse.
With their squandering of the Several Trillion Dollars of America’s confiscated wealth that will have been blown before this burst bubble is given the temporary appearance of having been patched, all the lifetime activist-”Democrat,” Paulson, the effective “Democrat,” President Bush and the rest of the feral gummint have achieved is to have pushed the “Democratic” party-caused absolute collapse of the United states’ feral gummint a little further down the road. And to have worsened the coming and inevitable absolute collapse’s consequences.
For all that is happened here is that an absolutely and abjectly corrupt (as the consequence of its every organ having spent eighty years in the corrupt and dirty hands of its “Democratic” activist owners, operators and controllers) institution: namely the feral gummint; having maxed out its every credit card, has now stolen another card — mine — and has used the stolen card to give the appearance of its having made a payment on its own, abjectly maxed-out, accounts.
If you and I did that sort of thing we’d be called thieves — and be called “nuts.”
And if we did it in the belief we were achieving other than moving our inevitable and absolute criminal insolvency a few hours, days, weeks, months — – or even a year or so — down the road?
We’d be called delusional!
There is a way out of this “Democratic” party-caused monetary meltdown — and it is called facing the consequences of the decades of criminality that led to it, tracing and erasing its causes — and allowing the Market to take over and put Right that which decades of looting by “Democrats” has brought about.
What passes here for “government:” — particularly as represented by the likes of the traitors, Roosevelt, Kennedy, Johnson, Carter and by the recidivist, lying, looting, co-serial rapist Cli’ton Crime Family et al — and more recently by Murtha and Frank and Dodd and the female Cli-ton and Schumer and Biden and Durban and Obama and their ilk — IS the problem.
And, until every one of those on that list, still alive — and his every co-conspirator — is locked away in prison, will never ever be other than the problem.
Brian Richard Allen
Oct 20, 2008 - 6:37 am 5. Quincy:Los Angeles – California 90028 — and the Far Abroad
David Wynn –
Your object to the author’s first point ignores the fact that the two largest players in the mortgage space were already directly influenced by Washington, and it was their actions–repackaging subprime debt as investments, cooking their own books, etc–that lead to the lack of transparency you talk about. Putting more banks in the position of Fannie and Freddie is not a good idea.
Also, if you believe that Congress will not try to manipulate banks into directing the money certain ways now that Uncle Sam has the whip, you’re quite honestly living in fantasy land. It WILL happen, especially with the coming Democrat supermajority in both houses.
Oct 20, 2008 - 8:12 am 6. Someone75:mjk:
I agree. Recession is a normal part of the economic cycle. To think we can prevent it is absurd. There are a variety of reasons concerning why we are where we are today. Time to face the music. If the economic world gets a shake-up, they had it coming.
Oct 20, 2008 - 12:17 pm 7. thegr8_1:There is a Wall Street Journal article today they did not know they had to book warrants to buy common stock as a liability when doing the capital infusion. The SEC and FASB had to change the rules or the banks balance sheets would be no better off with the infusion. Aren’t there any accountants who don’t need fingers and toes to count, hey Paulson why didn’t you call the I R S for help not that they are by any means intelligent.
Oct 20, 2008 - 1:46 pm 8. skink:just answer me this:
how many Canadian banks have failed during the recent crisis?
how many Australian banks have failed?
go figure
Oct 20, 2008 - 6:16 pm 9. David Wynn:@Quincy:
It’s true that the government played a role in encouraging home ownership, but the government didn’t force lending agencies to stop checking for borrowers’ ability to pay their loans, nor the banks the securitize the loans four times over, obfuscating the risk to where few could see what was coming.
The government also had zero influence in the credit default swap market, which is what caused the collapse of Lehman to spread to AIG and potentially beyond. No one forced investors to use CDS insurance policies as gambling chips, and to imply otherwise is dishonest.
Again, I agree that there was pressure from the government, but that doesn’t excuse the bad business practices at multiple levels that set up our financial system for these tough times.
And I would charge that if either party had a supermajority, they would aim to influence the banks in which they held stocks, not just the democrats. Despite this, I still think the liquidity injection plan is best because it’s the consensus view of economists at present, and puts money quickly into the hands that need it. That’s all that can be known for certain. What politicians will do 6 months from now is something we can only speculate about.
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Oct 21, 2008 - 2:59 pm 11. JFM:I am for bailing out the banks. Otherwise the economy would crumble like in 1929. Problem: bankers will have no incentive to staying on the safe side if they know they would be rescued in case things go wrong. Solution: Bail out banks but send their CEOs and members of the bord to jail. Not one of those jails for white collars where the border with outside world is a line on the floor. Picture Sing Sing or the prison in the “Miracle at Shanksville” movie, instead.
This way you can save the banks without fearing they will be still more reckless in the future. Their CEOs will have a
Oct 24, 2008 - 6:18 am 12. Will Becker:The place to start is with the Democratic congress.Liberal ideas just don’t work.
Oct 24, 2008 - 10:07 am 13. first history:The place to start is with the Democratic congress.Liberal ideas just don’t work.
Last time I looked the bailout was proposed by a Republican administration, which also had control of Congress for six of the last eight years, and did not pass any significant regulation of Fannie, Freddie, or the credit default swaps market. In fact, it was Republicans that created the credit default swaps market through theCommodity Futures Modernization Act of 2000, which has since cratered. See also the 60 Minutes report tonight.
If you don’t like partial nationalization of the banks, this week the Fed will be taking positions in <a href=”“>insurance companies.
The next Administration will be cleaning up this mess for years and we will be paying for it for decades.
Oct 26, 2008 - 8:46 pm 14. first history:Correction: This sentence should say: If you don’t like partial nationalization of the banks, this week the Fed will be taking positions in insurance companies. Also, GM reportedly wants government help with its merger wih Chrysler.
The handouts are just beginning.
Oct 26, 2008 - 8:55 pm 15. Jess:mjk:
Oct 27, 2008 - 5:02 pmAgreed. The government “bailout” was simply a redistribution of money and not a way to generate money that would stimulate the economy. They shouldn’t have been rewarded.