Bank nationalisation isn’t the answer

March 10, 2009

Free Market Foundation

Nationalisation appears to have worked well during the US banking crisis of the 1980s when the Federal Deposit Insurance Corporation (FDIC) recapitalised and took control of Continental Illinois Bank, which was then the country’s seventh largest bank. Today, however, the US 10 largest banking companies hold some two-thirds of the nation’s banking assets, and some are enormously complex. Continental had less than 2 per cent of the nation’s banking assets, and by today’s standards it was a plain-vanilla bank. This is important for three reasons, says William Isaac, chairman of the FDIC from 1981-1985, and current chairman of the Secura Group.

First:

Any bank we nationalise will be forced, both by the regulators and the marketplace, to shrink dramatically.

We are in the middle of a serious economic downturn where deflation is a realistic concern; do we really think that dismantling our largest banks would be helpful?

What’s more, we won’t be able to stop at nationalising one or two banks; if we start down that path, the short sellers and other speculators that the Securities and Exchange Commission still refuses to re-regulate will target for destruction one after another of our largest banks.

Second:

For nationalisation to work there needs to be a reasonable exit strategy; in the case of Continental, we had scores of options for returning the bank to private hands, including a public offering or a sale to any number of domestic and foreign banks and investor groups.

Today, who has the wherewithal, legal authority, and desire to purchase our largest banks?

No one comes to mind, particularly if we rule out foreign groups, which would not pass muster due to national security concerns about ceding that much power over our economy to foreign powers.

Third:

Who will run these companies when we dismiss the existing senior managers and board members?

We had significant difficulties attracting quality people to Continental even without today’s limits on compensation.

The Obama administration should declare that nationalisation of any major bank is off the table; that the government stands behind our entire banking system; and that our banks will continue to receive a nonvoting form of equity capital, such as convertible preferred stock, from the government to the extent needed, says Isaac.

Source: William M. Isaac, Bank Nationalization Isn’t the Answer; Trust me, I’ve done this before, Wall Street Journal, February 24, 2009.

For text: http://online.wsj.com/article/SB123543631794154467.html

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

FMF Policy Bulletin/ 03 March 2009