notes on bailout by nationalization

Extremely speaking, nationalization implies the government taking over every bank permanently and turning banking into a government service. There are also less extreme cases of temporary or partial nationalization.

How does nationalization really work?




Pros on nationalization (The Economist: “better a temporary ward of the state than a permanent zombie”):

- explicit government ownership is better than ad-hoc “deals” (injection of liquidities – welfare transfers from the taxpayers)
- raise capital rapidly for the insolvent institutions
- taxpayers will earn when the shares’ market value of the nationalized bank will appreciate
- debt holders are bailed out, except from the unsecured ones who will lose and, in this way, the market discipline will be recovered (and the problem of the moral hazard solved)
- solves the toxic asset problem (one possibility: through bad banks under conservatorship)


Limits on nationalization (Bernanke: [nationalization] “is when the government seizes the bank and zeroes out the shareholders… we don’t plan anything like that”):

- from necessity to obligation (contagion risk): if a bad bank is seized, other weak banks’ liabilities will start running
- uncertainty (whether nationalization or not) is costly: debtholders fears lead to increasing volatility; taxpayers will receive a share of the upside but also inherit the risks
- difficult to design incentive contracts for managers hired in nationalized banks
- the government might get attached to banks they control
- nationalized banks would have a competitive advantage over solvent, less supported banks


Cons on nationalization (Myron Scholes is in favor of nationalization "as long at it lasts just 10 minutes"):

- change of managers - maybe less competent ones, political interests & bureaucratic management
- at the expense of owners that lose everything
- banks’ unreliable assets are hard to value – impossible to know how much capital they need and expensive to provide it
- all over the world examples prove that nationalized institutions are less efficient than private ones
- any nationalized bank would be forced to reduce its activity because not that many risks will be taken and this could make the actual downturn even worse

(part of a group presentation on the propagation of the crisis and its management, march 2009)