Nationalization of the American banking Industry; What does it mean for taxpayers and investors?

The mere word “nationalization” strikes fear in the hearts of many free market capitalists, but should it? What does nationalization mean for the American public, what about private investors with a current stake in these companies? What will happen if these banks are not nationalized? What will happen if they are nationalized? Has any other country faced a similar situation, and if so how did they handle it? What was their outcome? By now, you’ve heard it all; Without the bailout the economy will collapse; This bailout is a farce, and taxpayers are footing the bill for Wall-Street bonuses. Who is right or wrong? Why did wall-street react so badly to the latest stimulus package approval? This analysis will attempt to answer all of these questions and more in hopes to educate the American public as to what the American Congress, Treasury, and President are attempting to do to remedy this current financial crisis, and if what they are doing seems to be the right course of action or not, depending on which side of the fence you sit, main-street or wall-street.

First, a quick (non-comprehensive) recap of what got us into this situation is necessary:

  • In 1999, The Clinton Administration urges Congress to allow Fannie Mae to ease lending restrictions “that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.” Although their intentions were probably good, lack lending standards allowed lenders to put individuals into positions they didn’t care if they could repay, because the money was too good.
  • In 2000, due to a re-assessment of the housing market by HUD, anti-predatory lending rules were put into place that disallowed risky, high-cost loans from being credited toward affordable housing goals. In 2004, these rules were dropped and high-risk loans were again counted toward affordable housing goals.
  • The early to mid 2000’s saw a boom in housing prices, as more and more consumers entered the market, driving up existing home values and real estate prices in order to meet demand, due to a limited supply. Not to mention, extremely short-sighted risks were taken in compensation for bonuses and fees by banks, loan authorities, and real estate investors. Moreover, existing homeowners took out 2nd mortgages in record numbers, and spent the money in every way imaginable, so when their home values dropped, many owed more than their property was worth.
  • By 2007, defaults on these sub-prime mortgages began to mount, and demand began to drop. Real Estate prices began their fast decline as defaults grew and demand dropped. Banks started realizing losses and investors began selling off their stakes in the mortgage back securities and the downward cycle began.
  • Consumers whom once had all of this extra money because of their second mortgages and booming economy, faced the tough reality that they were now spending money they really didn’t have. In short, retail sales began their rapid decline and so did most business in America and around the world. Just as home prices were artificially inflated by an artificial demand, so were stock prices, as consumers could not maintain their spending levels forever.

And so we’ve made it to current day, and we have watched a multitude of banks and other financial institutions collapse, while others have been saved, if nothing else temporarily. The government passed a $700 billion dollar bill meant to help the ailing institutions and stimulate the economy and consumer spending. However, the first one didn’t work as effectively as hoped and so another stimulus bill has been passed in hopes of curbing this recession. However, the second one has little mention of helping these banks further, and the market reacted negatively.

Now, back to the topic at point; What is Nationalization? For this discussion, nationalization means the government steps in and assumes ownership of the institution.

So, what does that mean for the American public? Keep in mind, there’s no clear answer to these problems, or they would have already been solved, therefore, all we can do is weigh our remaining options. Let’s consider a few options being proposed or that are in place to help correct our banking problems; Option A: Provide the largest banks with recapitalization, allowing the less market dependent banks to collapse, in hopes of attracting new private investors while allowing the market correct itself (which is what we’ve already tried and it hasn’t worked to attract many private investors); Option B: Allow them all to fail, hope new businesses will be able to step in and takeover; or Option C: have the government step in and take over control and hope they will be able to save them.

  • Option A hasn’t worked because it hasn’t restored investor confidence, and the credit markets have been partially frozen as a result of banks not willing to lend to each other in fears of defaults. Inevitably, these banks are destined to fail unless something miraculous happens. Not to mention, this option will drive up inflation.
  • Option B is extremely dangerous as we would be further risking a complete economic collapse. It would be quite difficult for smaller banks to even get financing to start operations. This option will likely make the blow more severe and fast, however, some may argue it is inevitable. The question then becomes, what is better, take one huge hit at once, or a bunch over a time period.
  • Option C is the last resort, by this time Option B has likely failed, and The US government steps in as the biggest business and guarantor of all. The problem becomes when do they step in, what adverse affects are caused such as inflation from printing money, among other issues like of lack of competition, etc. With this option, you effectively create a larger government, and in its nature is a bureaucracy and extremely inefficient.

It seems as if only a hybrid of these options makes more sense than one option alone. Option A seems to be useless, like trying to put out a high rise apartment fire with a single fire extinguisher. Instead of allowing private investors to pay for their risks, they tax all of the people and give them a minority interest, while allowing the same ineffective management to continue in their roles. It just seems as if throwing money at the problem won’t solve the issue. Private investors surely can’t mind this if they decide to stick with the company, rather than completely losing their investment. American People end up on the short side of the stick here, and investors make out better than they would have probably otherwise.

Option B seems most logical for the American public, allowing new companies to rebuild trust and redefine efficient and smart business practices. Investors probably fear this option, which may force them out of the investment market they are already wary of. Option C, given the Government doesn’t overpay shareholders for their equity positions – makes the most sense for the American Taxpayers, only if B doesn’t work first. If the government steps in, private investors get compensation, and the American taxpayer becomes responsible for footing the bills to maintain the banks. Having said that, keep in mind what these same people have done with Medicaid, Social Security, and the likes, and you will see that your chances of mismanagement may even in fact rise. The main objective in nationalizing the banks, at least in the short term, would be to restore investor confidence, etc. However, without effective legislation guaranteeing these banks won’t be allowed to do the same thing, the government would have a difficult time when privatizing the businesses once again to be able to sell the banks back to private investors,

Japan faced a similar situation to that of the US just over 10 years ago, here is an interesting analysis and comparison of their situation and attempted remedies as it relates to ours. They’re still fighting this battle today, and they used a combination of all three of the above approaches.

With regards to the most recent (2nd) Stimulus plan and why the market reacted so negatively, it should be quite obvious (I wrote a couple of articles about this). The new stimulus bill, unlike the last, does very little if nothing to aid the banks. In fact, most all of the spending is on social entitlements. It does however provide more tax relief so hopefully people will spend that money to help business. For those claiming this bill is a farce, I would agree it does nothing to address the banking problems, however, it does help a select group of people and tax-payers in general. To say we wouldn’t be any worse off without the latest stimulus, seems reasonable, to say the least.

Bottom line, Wall Street is looking for free hand-outs after having their hands slapped for scamming people by setting the market up for failure (as a result of what some would argue was congressional policy changes to accommodate low income families). No matter what though, most all people have some sort of tie to wall street, through their 401k plans or pension plans, through insurance products and more, to hurt them is to hurt yourself in many ways. On the other hand, the American people and investors alike question why you should give money once again to the same people that screwed us in the first place. There is no clear answer to our problems, however, there are clearly better options than others. Nationalizing our banks may be our last (and only remaining) option, however, if the government doesn’t immediately thereafter restore investor confidence, by reassuring investors past fraud will be prosecuted and the same problems won’t reoccur, this economy won’t come out this recession anytime soon. In fact, this may result in a complete economic collapse of the American Government and our currency, let’s not forgot what happened to the USSR not even 20 years ago, most academics laughed at the notion of their potential collapse.

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