What Happens When Banks Are Nationalized ( Learning from the history of other countries )

Seeking Alpha ^ | October 9, 2008 | Zubin Jelveh

[SeekAndFind]

Thanks to the fantastic and timely recent IMF paper and database on historical financial crises by Luc Laeven and Fabian Valencia, we can identify other instances in which a government took equity stakes in major banks as part of a recapitalization program.

This has happened five times since 1970, according to Laeven and Valencia:

Finland Jamaica Japan Korea Norway

Crisis date (year and month, respectively )

Sep-91 Dec-96 Nov-97 Aug-97 Oct-91

Recap cost to government (gross) (as % of GDP respectively)

8.63% 13.90% 6.61% 19.31% 2.61%

Recovery proceeds (% of GDP respectively)

1.72% 4.95% 0.09% 3.50% 2.00%

Recap cost to government (net) (as % of GDP respectively)

6.91% 8.95% 6.52% 15.81% 0.61%

Fiscal cost net (%GDP respectively)

11.08% 38.95% 23.91% 23.20% 0.60%

Output loss during period t to t+3 respectively

59.08% 30.08% 17.56% 50.10% 0.00%

In none of the cases did the government earn a profit from its move. The best return was in the case of Jamacia's 1996 crisis where the government earned 4.95 percent of GDP on the assets it had purchased, but the cost of the recapitalization was 13.90 percent of GDP.

Overall, total recapitalization costs ranged from 0.6 percent of GDP to 15.81 percent. For the US, that range translates into $85 billion to $2.2 trillion.

Total net fiscal costs ranged from 0.6 percent of GDP to 38.95 percent. For the US that ranges translates into $85 billion to $5.5 trillion.

Economic output loss over a three-year period following the onset of the crisis ranged from 0.0 percent to 59.08 percent.

In four out of the five cases, Laeven and Valencia point to financial liberalization as a key cause.

[ThePythonicCow]

Let's try the above table with its HTML formatting still in place:

	Finland	Jamaica	Japan	Korea	Norway
Crisis date (year and month)	Sep-91	Dec-96	Nov-97	Aug-97	Oct-91
Recap cost to government (gross) (as % of GDP)	8.63%	13.90%	6.61%	19.31%	2.61%
Recovery proceeds (% of GDP)	1.72%	4.95%	0.09%	3.50%	2.00%
Recap cost to government (net) (as % of GDP)	6.91%	8.95%	6.52%	15.81%	0.61%
Fiscal cost net (%GDP)	11.08%	38.95%	23.91%	23.20%	0.60%
Output loss during period t to t+3	59.08%	30.08%	17.56%	50.10%	0.00%

[NVDave]

They’re being selective in their choices of events to study.

Sweden went through problems in that time too:

http://www.riksbank.se/templates/speech.aspx?id=1722

[K-oneTexas]

Milton Friedman on Central Banking:

"There is no need for such arbitrary power... Any system which gives so much power and so much discretion to a few men, [so] that mistakes - excusable or not - can have such far reaching effects, is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic - this is the key political argument against an independent central bank.

"I am myself persuaded, on the basis of extensive study of the historical evidence, that... the severity of each of the contractions - 1920-21, 1929-33, and 1937-38 - is directly attributable to acts of commission and omission by the Reserve authorities and would not have occurred under earlier monetary and banking arrangements."

My most favorite on government intervention: ""If you let the government run the Sahara Desert, soon there will be a shortage of sand."

We saw Fannie and Freddie and now the nationalization of the mortgage industry. What fate awaits?

[kjam22]

What’s next? A government run system where you do what the government says or you can’t buy or sell anything.

[Cacique]

btt

[OneWingedShark]

> What’s next? A government run system where you do what the government says or you can’t buy or sell anything.

Maybe an “Obama” tattoo on the forehead or right hand...

[NVDave]

The problem in quoting Friedman here is that we have a parallel monetary and banking system that has arisen that is under no one’s control. It is devouring everything in its path - it is like a forest that has become full of tinder and fuel, and now the rising default rates of crap mortgages has put it to light.

So in reality, Friedman’s theories are only of use tangential use here.

And, BTW - there is a check on the Federal Reserve. We’ve already run up against that check. The Fed already ran out of money from their reserves already, and the Treasury did an auction of short term to help tide the Fed over.

Just this week, the Treasury did a $40 billion auction of notes in the belly of the yield curve. The political now has the power of funding restraint over the monetary.

[K-oneTexas]

I really don’t care of tangential. The quotes state facts. Please don’t tell me when and where to use a quote. You can take it or leave it. I don’t really care. They have to me, so I shared them.

[K-oneTexas]

I really don't care of tangential. The quotes state facts. Please don't tell me when and where to use a quote. You can take it or leave it. I don't really care. They have to me, so I shared them.

I do believe thay have relevance as this government has a p*ss poor record when it comes to management of anything. Past and present. This "bailout" will prove to be the biggest fiasco and burden on the American populace that they have ever seen or even contemplated.

Paulson I have no faith in. Benake I have no faith in. Any Obama noninee to those positions I know I will have no faith in.

The powers already granted the FED, SEC, Housing Department and others where sufficient to 'manage' this financial problem, however politicians need to create monumental edifices to themselves and their stupidity.

This has been mishandles and those quotes do support that.

[K-oneTexas]

The initial question was "What happens when the banks are nationalized." That what my quotes were aimed at, my thought on nationalization. Not my thought on this financial fiasco that we find ourselves in and you interpreted the quotes to.

The financial fiasco and crisis we now face is due to mismanagement by Congress, the Administration, particularly Fannie, Freddie, the Fed the SEC, Housing and a slew of others who should have had their eye on the ball and not lining their pockets and their friends. Greed on Wall Street also played a part at the behest and coercion of the US government. There is more than enough blame to go round. And enough to pass through Congress in their rush to put their finger in the dike. Talk this week is of the US government buying into the banks (ala Great Britain) and a new Breton Woods Agreement being necessary.

All this to help along the one worldness that we all so need desperately in the eyes of government and the bureaucrats.

Sound fiscal policy need to return ... however I'm not going to hold my breath. It will not come in my lifetime. This country regardless of party will sell us down the tubes ... its started.

[NVDave]

The quotes state the *opinions* of an economist, Milton Friedman. From any two economists, I can get five opinions.

The “shadow banking system” - those who have created, sold, bought and traded derivatives against debt instruments held by banks - have effectively created a secondary currency and obligations in that currency which is out of any control of the Treasury or the Fed. In light of this, your quote from Friedman’s is actually somewhat ironic: it was the instruments that were out of sight, accounting, control and regulation of the central banks that have brought this crisis to this point.

I agree with you that Bernanke and Paulson are doing an exceedingly poor job here. One reason why they are is that they have been hide-bound by “free market” dogma against taking ownership in banks in return for providing liquidity. This is why the Fed has frittered away over a trillion dollars of liquidity, swapping treasuries for illiquid debt instruments, without any conditions. The bidders on these auctions (eg, TAF, PDCF, et al) are getting a truly sweet ride. They get to give the Fed (ie, the taxpayers) some piece of illiquid paper of dubious credit value in exchange for a US Treasury. The only terms and conditions apply to the duration and interest rate of the loan. There are no other conditions. What a sweet, sweet deal for the bidders on these auctions.

The Paulson’ plan of buying illiquid debt isn’t being received with any conviction by the debt markets because it isn’t much better.

Compare the results of the Fed/Treasury, who are trying to cajole the large banks and players to do the right thing with the FDIC, who has the power to swoop down upon a bank that is about to fail and *force* it to surrender - they can force the executives out of their jobs, they can seize the deposits and hand them over to another bank, possibly a competitor, who is still functional. The interests of the depositors come first, not the whims and wishes of the bankers. The FDIC is having significantly better results and is doing more in their sphere to add stability than the Fed and Treasury are doing.

The SEC comes in for harsh culpability, because they allowed i-banks to go from 12:1 leverage to 40:1 leverage. The SEC failed to enforce applicable regulations they had, the SEC removed the uptick rule (and still, stubbornly refuses to reinstate same) in a display of dogmatic academic truculence. The uptick rule was a regulation installed after the crash of ‘29, when we went through a stock market crash where we had just day after day of free-fall downdrafts. It worked pretty well for years. So that’s another point against the free market dogmatists. We now have a stock market where it is as free as possible to short a company out of existence. The naked short rule isn’t being enforced. The uptick rule is gone. I don’t know about you, but I’d like a little regulation here just now.

The powers granted to the Fed are not sufficient to manage the problem. The Fed had no (and likely still has no) true idea of the size/scope/entanglement of CDS contracts. The Fed is operating off only what they know when one party in these contracts fails, and what they don’t know and are having trouble learning is causing this system to blow up. I’d wager that the Fed now wishes that they had not allowed Lehman to go belly up. The size of the counterparty exposure has been very destabilizing and has significantly accelerated this crisis. There’s $400B of notational value swaps from Lehman’s portfolio that are going to be resolved tomorrow. By Monday, another large bank might be toast as a result of what will happen tomorrow: open bidding in a nice, unregulated, ad-hoc market of unregulated instruments.

What is needed is direct government intervention in the banking system to force the banks to function. They might not function as well as free market dogmatists would like, but the important point that such people miss is that right now, the banks are not functional at all. We don’t have a top-level banking system just now - we have a bottomless black hole into which we’re throwing money without result.

The government might very well have to declare that the CDS contracts are simply null and void. Purists of tort law will likely howl like ruptured ducks - but they can do so at their leisure, because these people don’t have a better idea how to keep the US economy from following the failing banking system down a black hole.

Bankers, left to their own devices, can, do and will bring these problems down upon the population, once per generation. There are only two ways to avoid this: a) regulate banks to prevent them from chasing marginal returns at geometrically increasing risks, and b) eliminate fractional reserve fiat currency banking and return to a hard metal standard and a very limited limited fractional reserve system.

Since there isn’t enough gold to handle the US economy, we’re left with choice (a).

[K-oneTexas]

The quotes state opinions of economists - agree. However in the case of what do I think regarding central banking - it is the same.

I agree that economist opinions are all over the map.

Congress and the President (past & present) created this situation by removing safeguards. Step 1 is to reinstate them. The cows are out of the barn however future losses to globalist theory needs to be curtailed. Reinstating Smoot-Hawley would be a good step.

The $400 or $700b already given the Housing Dep't would help if used correctly and in conjunction with FED actions. Supplemental are all to often granted anyway and they will return to the trough, guarantied. Additionally, the "bailout" legislation should have limited Paulson to a specifi dollar amount and required formal requests for additional $ ... it did not. Congressman deniability is key here.

We need someone in charge not central to the fiasco. Paulson, Benake should be fired for incompetence, along with several more. Leman's former CEO/President should be gone from the US Treasury. As should all the other now out of work CEO's from defunct or sinking companies. We do have some smart folks on this subject sitting on boards of private companies that were not central to what occurred, they could be tapped for ideas and management.

We should bring back gold. We may not have sufficient amounts but could accumulate additional over time. A sold basis for our currency is what is needed ... not speculation.

I read two of the giant investment banks now want to be just banks to whether this storm. Maybe a good idea, maybe not. They need to be keep at arms length from the Treasury. Several of the companies we've already got to know should have gone bankrupt and had their assets sold to other established companies.

Fannie and Freddie being "merged" into a huge government bureaucracy isn't the answer. It is guaranteed that government will not turn a profit. Unfortunately, IMHO Sallie Mae will join them within the next 90 days. And the government as an insurance company (AIG) is ludicrous.

Government has in this instance (and others) proved Milton Friedman correct on "a shortage of sand in the Sahara". Proved it hands down.

Paulson also need to keep foreign banks at arms length and let their countries and governments take care of them. FDIC increase of insured amounts is good and should not be raised again, if ever.

This "bottomless black hole" (I agree) will only be solved with increased taxation ... the plan all along. It is a sorry can of worms created by government incompetence. We need to remember that at the ballot box next month. (my mouth to God's ear ... voters though have a very short memory).

IMHO, the free market can work us through this if we correct the supporting mechanisms that Congress has removed. Better supervision and oversight regulations, not direct government intervention and management.