Did We Nationalize Banks, Or Did They Nationalize Us?

By Simon Johnson

Hank Paulson’s testimony yesterday was informative, if only because it illustrated that he himself still understands little about the origins and nature of the global crisis over which he presided. Perhaps his book, out this fall, will redeem his reputation.

A fundamental principle in any emerging market crisis is that not all of the oligarchs can be saved. There is an adding up constraint – the state cannot access enough resources to bail out all the big players.

The people who control the state can decide who is out of business and who stays in, but this is never an overnight decision written on a single piece of paper. Instead, there is a process – and a struggle by competing oligarchs – to influence, persuade, or in some way push the “policymakers” towards the view:

1. My private firm must be saved, for the good of the country.
2. It must remain private, otherwise this will prevent an economic recovery.
3. I should be allowed to acquire other assets, opportunities, or simply market share, as a way to speed recovery for the nation.

Who won this argument in the US and on what basis? And have the winners perhaps done a bit too well – thinking just about their own political futures?

On who must be saved, we see the new dividing line. If you have more than $500bn in total assets, post-Lehman, you make the first cut. If you’re below $100bn (e.g., CIT), you can go bankrupt.

On remaining private, the outcome is more complicated. Citigroup (C) had the best political connections in the business, but turned out to be so poorly managed that the state essentially had to take over – in a complicated and ultimately unsatisfactory way. Bank of America’s (BAC) relatively weak political connections meant that the impulse purchase of Merrill Lynch could go very badly – and also led to a bizarre form of government takeover.

The prevailing idea and organizing principle for this new sorting is not Lloyd Blankfein’s “we’re the catalyst of risk” – investment banks are peripheral, rather than central, to nonfinancial risk taking and investment in this country. It’s Jamie Dimon’s idea: just don’t demonize the competent bankers, let us take things over and we’ll smooth it all out.

The problem with this approach is its “success”, from the point of view of the remaining bankers – their market share is up so sharply that it’s embarrassing. Of course, they can still argue that banking is a global industry with many competitors (some of which are even bigger, with more state assistance, promising much craziness in the years ahead).

But the real issue now is concentration in the political marketplace. Hank Paulson dealt with a dozen big banks/similar institutions with deep connections to Capitol Hill and a very powerful small banking lobby. Tim Geithner is looking at just a couple of big banks that are still independent . Probably we should start to divide our big banks into the “nationalized” and the “nationalizers”.

The small banks still have clout – and you’ll see them in force on the regulatory reforms debate this fall – but they know now that they don’t get bailouts, and access to contingent state capital-on-amazing-terms is the ironic basis of modern financial power.

We are looking at a concentration of political power in the US banking system that we haven’t seen since the 1830s: Shades of Andrew Jackson vs. the Second Bank of the United States. We put up with a lot from our banking elite in this country, but historically we draw the line at financial power so concentrated it can confront the power of the President.

The logic for reform and for breaking up the big banks begins to build. Bank of America’s fall was, in some senses, a fortunate accident for Goldman (GS) and JP Morgan (JPM). But it has also given them an excessive and unsustainable degree of political power.

Of course, you also have to ask: Who can break that power, when, and how?

Comments

[Longinvestor:]

It's really hard for superman, Paulson, to understand why people are upset about his saving of the world.

Jul 17 12:30 PM

[Harry Tuttle:]

Everyone knew that Paulson was too close to the problem to see it. He made his money at GS so it is logical that he believes saving the large banks equaled saving the economy.

That is why many voted for Obama. "Change," in this context, meant regulating those banks responsible for the crisis in order to avoid repeating the same mistake.

Except Obama appointed two insiders to handle the problem. Geithner and Summers, naturally, did their best to save...the banks.

As with the weapons of mass destruction fiasco, the masses initially believed the message of their leader. Once they discovered the deception they abandoned him and his gang (it took a while for Bush to fire Rumsfeld).

If the unemployment numbers don't get better (I mean more jobs, not fewer layoffs) Obama may face the same loss of credibility Bush experienced. The consequences maybe painful as well.

Jul 17 12:43 PM

[ejhickey:]

I was stunned to hear Larry Kudlow defending Hank Paulson. Essentially what Kudlow said was that Paulson may have broken the law and exceeded his authority but it was ok because he supposedly avoided a disaster. In other words the ends justify the means.

Of course Kudlow also said he expected a good earnings report from BAC. Just the opposite happened and BAC stock has taken a big step BACwards. So much for Kudlow's theory that they banks are profitable and will lead the economic recovery

Jul 17 01:31 PM

[Jason Rines...:]

You said it all and that bears repeating. In 2008 I had an opportunity to advise President Bush through a family member. I let him know to not trust Hank Paulson and that he did not care about the fate of the President's legacy or the American people. Hanky cares about his own ass and if the situation deteriorates into something much worse such a large scale military misadventure with other nations or revolution as a result of the American and global looting. It was the biggest heist in global history and one I doubt the global citizen will forgive so easily when all the truth is known, pleasant ass covering letter or not.


On Jul 17 09:59 AM ghostface killah wrote:

> On the contrary, Simon, I have to respectfully disagree with you
> on the point that Hank Paulson "illustrated that he himself still
> understands little about the origins and nature of the global crisis
> over which he presided". His bumbling, stupid professor act is just
> that, an act, so people won't believe that such an unpolished speaker
> could be so devious and cold-hearted. I believe Hank Paulson knows
> far too well, in fact, far better than the average American, EXACTLY
> the roots of this global crisis since his firm has been one of the
> major contributors to it. It's all just a show. Behind closed doors,
> Hank and all his buddies are laughing all the way to the bank, figuratively
> and literally.

Jul 17 03:20 PM

[Leftfield:]

Somehow I would believe Hanky's act more if it didn't involve the largest heist in history and saving his colleagues at our expense. Swindling the taxpayers out of nearly $1trillion in about a week, saying haste was essential, giving limitless powers and immunity to himself, don't ask questions, is too self-serving to pass as stupidity. Congress will plead the same if(!) they are actually asked hard questions at election time. Mainstream media will probably ask about favorite sports teams and the weather, though.

Jul 17 05:50 PM

[KIT:]

The whole group should have been Nationalized. The taxpayer once asked to fix the mess would now be benefiting from the profit. Once the bailout was recovered and new rules put in place the taxpayer could sell the working company to the private sector. This would elliminate the moral hazard of no down side for doing wrong.

Jul 17 06:31 PM

[Moon Kil Woong:]

The author is right on 2 facts, power is being concentrated and the winners and losers are clear and apparent. Regarding this:

"Instead, there is a process – and a struggle by competing oligarchs – to influence, persuade, or in some way push the “policymakers” towards the view: My private firm must be saved, for the good of the country. It must remain private, otherwise this will prevent an economic recovery. I should be allowed to acquire other assets, opportunities, or simply market share, as a way to speed recovery for the nation.
Who won this argument in the US and on what basis?

The answer is obvious as it is expected. The Federal Reserve, architect of this mess is the winner. But rather be saved they increased their power. Rather than remain private they are being ordained even more power that they selectively never use for the good of the general public. And regarding acquiring other assets, they were given the right to buy Treasuries themselves and to blow up their balance sheet without any restraint, Congressional oversight, audit, or authorization. Frankly, I can't think of a bigger way they could win asides from declaring all US assets as their own.

Stewie from Family Guy would have been proud of the Fed and Paulson. Paulson got the biggest bazooka he could only to give it to Goldman so they could use the money to build the biggest program trading system taxpayer money could buy. Pretty soon they'll represent like 80% of all equity trading with "software that could let others manipulate the market." The whole thing would be comical if it weren't so real.

Jul 18 05:55 AM

[Michael Clark:]

It's not too late to nationalize them. Obama won't do it. But as the facts get out, anger at the financial ruling class is going to make them much more vulnerable politically. (Paulson made $400 million from GSachs. Of course he's going to defend them.)

Jul 18 10:46 AM

[redwine44:]

We voted in those Congressmen, and they voted to give Paulson the blank check. Our brave 5th estate of reporters & journalists did not have a clue what any of this was all about or what the un-intended consequences are, since they mostly come from colleges that still teach from the view of Marx, Engels, & Lenin. The general maistream news media of today is so far behind the curve they don't even know what road the world is driving on. Totally out of touch with economic reality, they mostly have never studied any real US history such as the fight between Hamilton and Jefferson over things like founding the 1st Bank of the United States, Pres. Jackson who killed it off, and the various recurring financial panics and so forth. (See Frank Baum, the Wizard of Oz, yellow brick gold road vs. the paper money crowd.)


The alternative to a well informed citizenry and Congress is either this, a recurring bank melt where we all get taken for a few $ to restore liquidity, or, we can go back to a monarchy where the same thing happens but the King IS the decider, communism with no incentive to create any wealth, or dictatorship, a la Stalin or Hitler. I would like to choose the option of cleaning out the colleges but I don't think I have the power to do that.


My favorite snippet from the testimony was when Paulson was accused of selling his GS stock when entering govt. service and deferring paying any income or cap gain tax on the gains. Well, did Paulson write the tax law, or did the Congress?

Jul 18 12:24 PM

[MudEngineer:]

I believe a better route would have been for the whole group to have been euthanized not nationalized. All the various parts worth saving of these large banks would have been bought up by smaller and more local banks that did not partake in the derivatives stupidity. The various large banks branches could have been absorbed into nearby local banks or been closed if too close to existing branches of the local banks. The whole country would have been better off with those too big to fail behemoths gone. They hold too much power to sway our politicians or should I say bribe them.


On Jul 17 06:31 PM KIT wrote:

> The whole group should have been Nationalized. The taxpayer once
> asked to fix the mess would now be benefiting from the profit. Once
> the bailout was recovered and new rules put in place the taxpayer
> could sell the working company to the private sector. This would
> elliminate the moral hazard of no down side for doing wrong.

Jul 18 08:16 PM

[nova:]

Harry Tuttle wrote:
"Except Obama appointed two insiders to handle the problem. Geithner and Summers, naturally, did their best to save...the banks...
If the unemployment numbers don't get better, Obama may face the same loss of credibility Bush experienced."

I believe you give too much credit to American people intelligence.

Jul 18 09:51 PM

[Angry Banker:]

Very well written article. The comments have been inane, but the article was well written. I would like to respond to one theme in the comments though - the idea that taxpayers have been ripped off. So far, the banks have been paying very handsome dividends on the taxpayer's investment and several banks have already repaid the principal. So who's been ripped off?

Jul 19 03:34 AM

[dcb:]

So simon,
Where is the petition for me to sign saying that I agree with you, the one that says I want real reform efforts and a decrease in systemic risk. I'm happy to sign and I am sure would so many or your readers. But you don't put one up. Why?

Jul 19 07:22 PM

[dcb:]

I'm sorry for being insulting, but you're either clueless or just choose to look at information that supports your viewa. A rational human being can even have a conversation with someone like you because you're way too far gone. If in the thousands of posts on this site you have not been able to figure out how the tax payer and citizen is being ripped off there is no hope for you.

bailing out the banks and allowing them to manipulate the markets increases the costs of commodities and causes future inflation and lowers the dollar. this increases borrowing costs which I the tax payer have to pay back. given to the banks for free at the discount window. Add to that lost interest income in my bank account. those are just indirect macro economic effects. federal backed loans which if they have a problem I have to pay back. AIG, Talf, Tarp, the treasury not getting fair value for the warrants, don't forget cheap funding for the commerical bailout now too. I subsidize all of those funds given to banks at below inflation have to pay it back in taxes at a higher rate, and then get my tax money lent back to me from banks at rip off credit card rates.

How about foreigners not wanting to hold dollars and the systemic risk that poses for dollar collapse. How about the effect of the defecit on borrowing costs.

That's just a small list.

That bonus money is my tax dollar and would not have been able to be done without it. How about the corporate tax rate goldman pays. I believe it's 10% (not sure). You think you're angry banker, I could throw you to a mob of people and you would be ripped apart. You don't know what real anger is. Believe me there is nothing I would like to see more than an angry mob down on wall street, because nothing else appears to get the governments attention.

The truth is I am unwilling to put words to paper that are insulting enough to express your lack of understanding. It is this lack of understanding that into the situation in the first place.

You remind me of John Thain. didn't see anything wrong with asking for his crazy bonus, and didn't see anything wrong with spending so much on his office while his company went down in flames. You and he are really very alike. JUST DONT GET IT!!


On Jul 19 03:34 AM Angry Banker wrote:

> Very well written article. The comments have been inane, but the
> article was well written. I would like to respond to one theme in
> the comments though - the idea that taxpayers have been ripped off.
> So far, the banks have been paying very handsome dividends on the
> taxpayer's investment and several banks have already repaid the principal.
> So who's been ripped off?

Jul 19 07:41 PM

[dcb:]

Oh, I forgot to add that it really doesn't matter if they pay back tarp because they know if they get in trouble again the tax payer will bail them out. so godlman has increased it's VaR (which is backed by my tax dollar) actually increasing systemic risk instead of decreasing it. I am giving a subsidy for them to increase systemic risk. they will get the bonus, I eat the losses if they have any.

But, hey I can't see why the tax payer would be angry. we are paying back the money.

On Jul 19 03:34 AM Angry Banker wrote:

> Very well written article. The comments have been inane, but the
> article was well written. I would like to respond to one theme in
> the comments though - the idea that taxpayers have been ripped off.
> So far, the banks have been paying very handsome dividends on the
> taxpayer's investment and several banks have already repaid the principal.
> So who's been ripped off?

Jul 19 07:46 PM

[dcb:]

Hey, angry banker. you want angry try this. this is me and there are hundreds of thousands of us, and I want millions!!!

dailybail.com/home/the...

Jul 19 07:49 PM

[dcb:]

try this one angry banker. maybe you'll get it. but I guess congressman grayson is a fool too.
it's about paulson and his 700 million dollar conflict of interest

dailybail.com/home/ala...

Jul 19 07:59 PM

[Angry Banker:]

Hey I'm not defending Paulson at all (you can read my articles on this topic), but my point is plain and simple. The government loaned and/or invested money in the banks. The banks are paying it back, so nobody's getting ripped off!

By the way, your taxes have not been raised, so the taxpayer has not actually paid anything more for bailing out the banks. And don't give me any crap about the burden this puts on our kids. The money will be repaid, so there is no future burden. And as for the taxpayers, guess what, I'm a taxpayer too. In fact, I pay a LOT of taxes. And those bonuses paid to the bankers? They paid lots of taxes on those too. Oh and the profits the banks are making now? They pay 36% on those. In fact corporations pay a hell of lot more taxes than individuals, so since the corporations are the biggest contributors to the country's tax revenues, it should not be a problem if every once in awhile the companies get some benefits from those taxes too!


On Jul 19 07:59 PM dcb wrote:

> try this one angry banker. maybe you'll get it. but I guess congressman
> grayson is a fool too.
> it's about paulson and his 700 million dollar conflict of interest
>
>
> dailybail.com/home/ala...

Jul 20 05:48 AM

[Al-USA:]

redwine44 wrote:
"
My favorite snippet from the testimony was when Paulson was accused of selling his GS stock when entering govt. service and deferring paying any income or cap gain tax on the gains. Well, did Paulson write the tax law, or did the Congress?
"

Redwine44 writes the above in the comment section of an article written by the same author who also wrote, "The Silent Coup", in the Atlantic, a few months back...

If he had read, "The Silent Coup", redwine44 would see the inappropriateness of such a comment.

More information below:
Banks Counted on Looting America’s Coffers
tinyurl.com/bkezmt

The Quiet Coup by Simon Johnson
www.theatlantic.com/do...

"The Fed's War on the Middle Class"
mises.org/story/2983

Jul 20 08:17 PM

[Pro2Pro:]

This is well written article and you've made some valid points. Paulson is unable to stand back and evaluate the situation from the outside. It's no surprise that he equates saving big banks with reviving the economy.

Jul 23 10:38 AM