MainStreet Explains: Nationalizing Banks


When people talk about U.S. banks being nationalized, what do they mean? MainStreet turned to some financial experts for answers. Here is what we learned:

Nationalization: A Definition
In its purest form, nationalization is when a national or state government takes over an industry, making it federally or state-owned and operated. It’s considered total government ownership, with Uncle Sam acting as CEO. And now the notion is back in the news, amid the turmoil in our country’s banking industry, as our government struggles to find a way to manage the crisis. 

Nationalization: The Current Controversy
The notion of nationalization sparks great debate. Advocates say it is vital to nationalize in times of crisis to systematically reform an industry, to keep jobs alive and to keep the economy operating. When it comes to the current banking crisis, some believe that some degree of nationalization may be the only way to keep banks afloat and solvent.

Critics argue that nationalizing industries or individual companies goes against our country’s founding model of capitalism and others caution that it creeps our country ever closer towards socialism. 

“It would be George Orwell’s Animal Farm,” says Bill Bartmann, the former CEO of Commercial Financial Services and author of the upcoming book, Bailout Riches.  According to Bartmann, there would be little to no competition among firms.  There would be no point in shopping around for the best interest rates like we do now, and getting through to customer service would take much longer, with service being mediocre.

“It would be like military music or government medicine,” says Bartmann. “Neither is very good.”

Nationalization in U.S. History
There have been varying degrees of nationalization in U.S. history. In 1917, President Woodrow Wilson’s administration completely took over the railroad industry in an attempt to make transportation more efficient during WWI. A similar action took place in WWII with the auto industry. That’s one end of the spectrum.

On the other end sit certain federal requirements that apply to all industries at all times that are, arguably, forms of government intervention. For example, when two companies want to merge, they need to get federal approval.  And when banks want to borrow money from each other, they must refer to the Federal Reserve’s monetary policy.

“Banking has never been completely outside of government regulation and supervision,” says William Silber, the Marcus Nadler Professor Finance and Economics at the NYU Stern School of Business.

Somewhere in the middle lies what happened to some banks during the savings and loan crisis in the 1980s and 1990s, when the Federal Deposit Insurance Corporation, or FDIC, chose to place several banks under receivership.  This happened after the FDIC deemed an institution insolvent, meaning its liabilities were far greater than its assets. The FDIC operated the bank until it managed to find it a suitor, which could take anywhere from a week to more than a year. 

“It’s sort of like a bankruptcy process, only it’s much more structured with much more certainty for all the parties concerned,” says Lawrence White, the Arthur E. Imperatore Professor of Economics at the NYU Stern School of Business.

Nationalization: Where We Stand Now
The current bailout appears to favor a partial nationalization approach, at the least. It falls somewhere on the middle of the spectrum, with the ability to slide further towards full-on nationalization. The Troubled Asset Relief Program, or TARP, which granted cash infusions to some 300 banks, comes with strings attached, including an open door for complete government overhaul and management if necessary. (After all, the government is buying equity in these institutions.)

The government took bigger equity stakes in some larger financials that are in grave danger of failing like Citigroup (Stock Quote: C) and AIG (Stock Ticker: AIG). These two banks received far greater sums of money, $45 billion and $40 billion respectively, and are consequently under heavier government supervision than banks that received less help. Some employees of Citi and AIG now joke that they “work for the government now.”

But it's technically not a joke. All banks under TARP must limit their dividends, executive compensation and bonuses. Additionally, the feds can hire and fire employees and make new rules as they see necessary.

The administration is now toying with the idea of creating a “bad bank,” which would act as a clearing house for banks to dump their estimated $1 trillion in toxic mortgage-related (and other) paper. Using taxpayer dollars, the government would buy these tarnished loans with the ambition of selling them back to the marketplace at a profit, if conditions improve. That, of course, is a big if.



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