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Relitigating Summers and Bank Nationalization

There's been some teeth-gnashing in the liberal blogosphere over Ryan Lizza's New Yorker profile of Larry Summers, the general thrust of which is that he supposedly went too easy on Summers, particularly on the issue of bank nationalization. Here's Dean Baker over at his American Prospect blog:

In terms of the bank bailout, some of us were worried that we were effectively taxing the whole country to support the rich bastards that put the economy in the toilet. Bank profits now stand at a record share of GDP and the bonuses at Goldman are as big as ever. What did the critics get wrong?

I didn't get into the nationalization debate in my earlier post about Ryan's piece, both because I think he got it right, and because I've pretty much said everything I have to say about nationalization already. But as this is apparently still very contentious, I'd just make a couple points in Ryan's (and Summers's) defense:

1.) Are the optics/politics of having taxpayers subsidize banks back to profitability pretty lousy? Yes, they're lousy. But much worse politics, I think, is a botched attempt to nationalize banks.

2.) Is having taxpayers subsidize banks back to profitability offensive from the standpoint of distributive justice? Yes, very offensive. But much worse from the standpoint of distributive justice is spending a couple trillion dollars to nationalize banks and failing to solve the problem--possibly making it much, much worse.

3.) Were there good reasons to believe that bank nationalization would fail? Yes, extremely good.* In fact, when Larry Summers grilled Tim Geithner on whether his plan was aggressive enough--and whether nationalization might be something worth considering--Geithner came back and laid out all the numerous ways that nationalization could be a fiasco. And Summers, who is not known for his credulousness in discussions of economic or financial policy, was persuaded.

You simply cannot talk to these guys and not appreciate how much some of them wanted to be more aggressive with the banks at various points--Geithner would say as much when he got agitated in internal discussions--but realized they couldn't in good conscience recommend that course to the president. And they were right. (For what it's worth, I say this as someone who initially supported nationalization.)

*Ryan lays out some of the reasons nationalization might have been a disaster:

In the end, though, Summers acknowledged that there were no better options, and Geithner’s plan survived intact. On March 31st, Summers sent the President a page-and-a-half memo outlining the reasoning behind the decision not to nationalize any banks. Obama was on his way to the G-20 meeting in London, and he wanted to be prepared with the best case against it.

The memo was divided into four sections. First, Summers explained that there was no legal authority to take over large bank-holding companies like Bank of America and Citigroup. Next, he pointed out that full nationalization of a financial institution might trigger systemic shocks, as investors retreated from other banks, creating exactly the kind of panic that nationalization was intended to prevent. (As Sperling often argued, “You might come out and say, ‘I’m gonna take over Bank of America and Wells Fargo, but everybody else is safe!’ Maybe they believe you. And maybe they don’t. But if you get this wrong the Dow’s at thirty-five hundred! You’re the worst economic manager in the history of the United States!”)

Furthermore, Summers said, there was a medium-term risk that nationalized banks would lose value, in the same way that the act of foreclosure decreases the value of a home. Summers pointed to the example of Sweden, which was regularly cited by economists who favored nationalization. But Summers noted that Sweden didn’t nationalize for two and a half years, by which time the situation had become so severe—interest rates had reached a hundred per cent—that there were no other options. In addition, Nordbanken, the largest bank nationalized in Sweden, was already eighty per cent government-owned. Summers concluded by emphasizing that nationalization was a strategy that governments turn to only after it is very clear that nothing else can work.

I laid out some related reasons in my profile of Lee Sachs (Geithner's chief financial markets advisor) this summer:

Around Treasury, Sachs was fond of comparing the decision to seize a large bank with the decision to invade Iraq. "There are hundreds of billions of dollars of value in these institutions," he'd say. "If you're going to go and destroy that ... you'd better know there are WMD there." ...

What these critics missed was that Treasury was prepared to take over the banks if necessary. But Geithner and Sachs had practical reasons for their lighter touch. "Lee's great strength is that he's exceptionally careful about thinking through implications of any particular choice," Geithner told me. "He's got a very good feel for markets and a sense of what practical considerations apply." The two men worried that nationalization would trigger an exodus of bank personnel. If that happened, it would leave the government with all the risks a bank was shouldering and all of its losses, but with no way to generate revenue--or, for that matter, to sell it back into private hands. These were the kinds of concerns that resonated at the March 15 meeting with Obama. "That was the moment it really hit a lot of people that, rather than Tim and Lee looking cautious, maybe they were thinking through the risks at a deeper level than other people were," says one administration official. (Sachs declined to comment for this piece.)