2009-02-23

The U.S. should probably nationalize banks

The situation in the U.S. currently appears to be like this:
  1. Everyone is used to paying for their houses and cars with loans.
  2. The U.S. tax system, in fact, is geared to encourage taking loans and discourage saving up and then buying. (I'd like to learn more about that; this is what I heard.)
  3. Banks have made investments for which they are now not sure to what extent they will be repaid. Each individual bank is therefore compelled to abstain from loaning and to bulk up on capital until they know what their situation is.
  4. Since most banks are in the same situation, however, most banks are abstaining from loans, and people cannot get financing for their large purchases.
  5. In a no-loan environment, it will take years before most people save up enough money to buy houses and cars with cash. When they do, the houses and cars bought this way will tend to be smaller and more economic.
  6. In the meanwhile, as most people have neither loans nor savings, houses and cars aren't getting sold.
  7. Houses and cars not being sold causes prices to fall, people to go out of work, incomes to drop, and therefore even less houses and cars to be sold.
  8. As real estate prices drop, the number of people who will walk away from their mortgages rises.
  9. As more people walk away from their mortgages, there are more foreclosures.
  10. Banks lose money on foreclosures, so therefore, the worse the real estate market gets, the more threatened the banks feel, and the less likely they are to lend.
In this situation:
  • Tax cuts won't help. The state of the economy is such that people will place most of that money into banks, who won't lend it, so it will lay dormant.
  • Stimulus can help a little bit, as long as it is spent paying people who will actually spend most of it, i.e. people who would otherwise be unemployed. Even so, any multiplier effect will be minimal, because after a couple of transactions, the money will just get stuck in banks again. Also, if stimulus is spent on paying people who would otherwise have jobs regardless, it's being wasted; that money will get stuck directly in banks.
But neither stimulus nor tax cuts address the crucial part of the problem, which is that money is getting stuck in banks. What the banks are experiencing is in fact a coordination problem. For any individual bank, it makes sense to wait and see, for fear of a catastrophe. But when all the banks are doing this, the fear of catastrophe is self-fulfilling. In order to avoid this, banks therefore all have to be made to start lending at the same time. There is only one entity that can arrange this, and that is the U.S. government.

Banking shares are already trading at next to zero, and will approach zero along with the rest of the economy if the situation continues.

Therefore, the U.S. government should probably nationalize banks in the short run, make them lend, and then as soon as the economy recuperates, turn the banks around to the highest bidder.

11 comments:

Anonymous said...

interesting...

crazy enough tha it might just work.

at a time when no one has money to spend--lend them money. makes sense.

Thanks Mr. Bider

denis bider said...

Well, the reason why no one has money to spend is because banks have stopped lending. It's not like America was running on its own savings before. :)

What I am discussing here is however an idea that it appears has been fairly obvious to economists. I recall several calls for such a measure even just on the Economist.com Free Exchange blog.

tim said...

the interest that is earned in a savings account is taxed.

with a mortgage, the interest that is payed can be deducted from one's taxable income, thus lowering the overall income tax bill.

Daniel said...

Perhaps a lesser known fact- nationalization is already well underway in the US. The FDIC is buying stocks and zeroing out shareholders of banks that it deems insolvent at a rate of two banks per week(according to Krugman), for some time now. It cleans up the balance sheets and sells them on later.
Only that these are small fishes not the big mastodonts of Citibank callibre.

I agree with the plan. Keynes said that we should approach an economic system not as a morality play but as a technical challenge. Well the best technical solution for the current mess is nationalization(and subsequent privatization).

Žiga Turk said...

But give or take some details, the banks are not lending, because it does not make economic sense for them to lend.

Government forcing them to do what is stupid would not help. Instead measures should be taken that would make lending economically sound.

And the problem is too big to do this just by low FED interest rates.

denis bider said...

Daniel: interesting, and to an extent I would agree with that statement attributed to Keynes, but sound principles are also an important part of the equation - though not one for which it is worth sacrificing everything. Anyway, principles that would require such sacrifice are not sound principles.

Žiga: The problem I was trying to describe, and in which I have apparently to some extent failed, is that actions that would be good for all banks as a whole, are stupid when considered by each bank individually, and vice versa. That's what I meant by saying it's a problem of coordinated action.

Daniel said...

denis:
In my view, principles are a luxury, that you can afford in a healthy economy. When it goes south, then you must pick the most technically sound solution.

Interesting article, about Wall Street's reliance upon one mathematical formula, that led to it's demise. Explains quite well why were the investors feeling confident at betting big on the (as it turned out now) myth of Never Declining Prices of Mortgages.

Daniel said...

Never Declining Prices of Realties :)

Daniel said...

Žiga,

as far as I understand the problem of this mess(and I'm not an economist:) is twofold:

1.) There is no lending between banks, because no one knows how much of the toxic mortgage backed securities their counterparty holds.

2.) There is no lending to the companies, because banks don't know if the borrowers are going to survive the recession.

With nationalization the first problem is solved by goverment (taxpayer) money helping to clean up the balance sheets.

The second one exists because the company's(this holds true for nearly all firms) business strategies rely on refinancing- once they can't get new loans this strategy fails.
It won't help nothing if one bank starts lending, because if the business partners of the borrowers won't get loans they'll go bust and consequentially the borrower with them. If all banks start lending then it's obvious that this problem perishes.

Daniel said...

There goes the nationalization.

Krugman explains why it will be a failure. I think he made a good case for it.

denis bider said...

Thanks for those links. I liked Krugman's article.