Time Not for a Bailout, But for Nationalization

John McCain and the House Republicans have blown up the Paulson-Dodd-Frank compromise--for that's what House Republican Whip Roy Blunt says that John McCain did:

Roy Blunt: Everybody else seemed to be rushing for a deal and John McCain came back and said, ‘Wait a minute, I think the House Republicans have the taxpayers in mind and I’m with them’...

Now it's time to go back to three principles. There are three options:

• Do nothing.
• Bailout (a la Paulson)
• Nationalization (a la Sweden 1992)

Do nothing was last tried in 1929-1932. The result was called the Great Depression. Let's not do that again. Let's decide between bailout and nationalization.

Nationalization has the best chance of avoiding large losses and possibly even making money for the taxpayer. And it is the best way to deal with the moral hazard problem.

It might work like this. Congress:

• grants the Federal Reserve Board the power to take any financial firm whatsoever with liabilities and capital of more than $25 billion that is not well capitalized into conservatorship,
• requires the Federal Reserve Board to liquidate any financial firm in its conservatorship when it judges that the firm is insolvent (paying off in full or not paying off in full the liabilities of the firm at its discretion), unless
• the Federal Reserve Board finds that preservation as a going concern is in the interest of the taxpayer, in which case Congress
• grants the Federal Reserve Board the power to transform equity stakes in the firm into junior preferred stock at par value and then transfer ownership and custody of the firm to the Treasury,
• requires the Federal Reserve to terminate conservatorship if the firm becomes well-capitalized once again.

In addition, Congress:

• grants the Treasury the power to issue up to $500 billion of troubled asset redemption bonds, the proceeds of which are then to be loaned to the Federal Reserve to be used to cover the liabilities of those liquidated firms that the Federal Reserve judges it is in the interest of the taxpayer to have their liabilities paid off in full.

Paulson had his shot. It's time for the Democrats to pass a nationalization in the taxpayers' interest bill and dare Bush to veto it. If he does, then announce that the congress will pass it again the day after the election. And if he vetoes it again, announce that congress will pass it yet again on January 21, 2009.

Comments

[PearlCreek:]

Every academic economist should be given a one year sabbatical. These people are as useless as sports talk radio hosts. A bunch of bleacher bums with zero skin in any free market enterprise. Tenure? Skyrocketing tuition?

Give us all a break from theory.

2008 Sep 27 02:51 PM

[Respirate:]

I like it. nationallize, then re-privative the businesses into a better market. It's the only way to ensure the taxpayer again ends up with zilch.

2008 Sep 27 03:04 PM

[Hopefull:]

The main thing here is to have a intelligent reliable group under the auspices of the Federal Reserve value these mortgages using discounted cash flow and updating these values weekly. After these values are established then let us see what the landscape looks like. After all, JPMorgan Chase valued the WAMU mortgages,etc.

2008 Sep 27 03:04 PM

[najdorf:]

Two questions for know-nothing troll:

How do you know how much skin the author has in free market enterprises?

What ideas in this post are more theoretical or less practical than the Paulson plan or the House Republican plan?

The post provides concrete recommendations and you flip out because there are books behind the author in his picture. It's ok - avoid all educational institutions and keep voting for politicians who are as dumb as you are. Count yourself lucky that W. appointed people with records of success in business and academic endeavours (Paulson and Bernanke) to bludgeon the politicians into fixing the problem. At least he's smart enough to know that Treasury and the Fed are more significant to his way of life than FEMA and the Department of Education.

2008 Sep 27 03:09 PM

[Purl Gurl:]

Brad Delong writes, in part, "John McCain and the House Republicans have blown up the Paulson-Dodd-Frank compromise...."

Oh my, Mr. Delong, you are a partisan leftist socialist, yes?

Rather clear your thinking is tainted by partisan concerns rather than concern for our American peoples. This economic crisis is a national issue, is a global issue, yet you are sitting there thinking leftist socialism.

I am a registered democrat. I am voting John and Sarah because I think clearly and because I am partial to good common sense. I do not make decisions based upon political party affiliation rather I make decisions based upon what I believe will be best for all peoples.

You disqualify yourself as a commentator upon playing party politics when this comes to issues which both effect and affect all peoples.

Mr. Delong continues, “Let's decide between bailout and nationalization.”

Bailout, this is to reward Wall Street criminals for their financial crimes against America.

Nationalization, is not this a tactic of Banana Republic despots?

Best option is the “Do Nothing” option. Wall Street should be allowed to collapse. Our economy and our global economy should be allowed to collapse. We need a repeat of the Great Depression to cull the flock. America and our world need to be rid of Wall Street types and be rid of peoples who refuse to live a lifestyle within their means. Wall Street is not solely responsible; our politicians and our peoples are equally responsible.

Yes, I am advocating economic collapse leading to loss of jobs, loss of homes, families ending up on welfare, maybe homeless and on the streets. This breaks my heart because of innocent children who will be victimized by adults who made bad decisions and gave over to greed.

If I could protect children of our world, I would financially nuke our world.

All in our family were born to poverty on a rural Oklahoma farm, many decades back. We were born ignorant, could not attend school, never enjoyed money, literally, then we set about working our fingers to the bone to attain financial security. Yes, this economic crisis has reduced our family wealth quite significantly. Nonetheless, we are very comfortable; we enjoyed sense enough over the decades to stash away cash for rainy days. We have no debt, no credit card debt, no mortgages on our home nor our income properties. No debt at all. Reason for this is our family made a point to do without, to sacrifice, to work hard, to move ahead in life by living well within our means and ways; we hold ourselves financially responsible.

Why should our family bailout Wall Street and Americans who are financially irresponsible?

Let the chips fall where they may. Our world needs culling.

Pity the children of our world, though. This hurts me deeply.

These leftist socialist bailout and nationalization notions will prove an albatross around the necks of hard working honest peoples who did not contribute to our current economic crisis.

Survival of the Fittest is Mother Nature’s way. This is precisely what we need.

No bailout, no nationalization. We need to cull this diseased chicken flock we call America and call, our world.

Okpulot Taha
Choctaw Nation

2008 Sep 27 03:28 PM

[Kimberly Pe...:]

John McCain has not in my opinion communicated his economic positions well. Below is my attempt to clarify them.

McCain believes in Jeffersonian Democracy. What does that mean? Thomas Jefferson argued against Federalism, as he felt that it posed a risk and infringement to the liberty of Americans. The Federal government is a necessary evil, which should operate on the common benefit, security, and protection of Citizens, and should be watched closely and its powers should be minimized.
Science recently has determined that there is a scientific reason why this is the best possible configuration. Networks of all types, financial, government, electrical, communicative, all behave under certain laws. These laws have been described well in layman’s terms by Lazlo Barabasi in his book “Linked.” These laws argue against centralized networks as they are prone to cascade failures and that distributed adaptable networks are much more robust and capable of sustaining damage to one part of the network and reconfiguring themselves and continue to function. What this tells you is that democracy and capitalism, is inherently more stable than other types of systems of economic distribution and governance.

Capitalism has been moving towards big business, since the industrial revolution, and this has led to a centralization of Wealth which has placed our economy in the current economic crisis we face today. It is not accurate to place the blame on Wall Street, or on homeowners, for the current financial crisis. The crisis was driven by the centralized wealth and dynamics of the networked global economy.
The solution to the problem is to move toward decentralization of all critical networks such as Government and Financial.
McCain holds that we need to move from Big Business to many competing companies run on Main Street, and incentivize investment in small business over big business.
McCain also holds that regulation much like Big government needs to be circumscribed in its powers, but that it’s a necessary evil. The idea is that centralized standards, and regulation, reduce the cost of compliance and lead to greater efficiency.
McCain understands we need regulation and standards, but regulation and standards must be able to evolve and adapt, while cost of compliance must be the same for individuals as for big business on a basis that places the individual or small business with an equal footing to gig government or big business.
(In my opinion, this needs to be slanted towards small business and individuals. That it’s better to err on the side of smaller concerns.)
McCain is against Obama’s tax plan, because increasing capital gains tax on business, and investment, because it acts as a barrier to deploying monies to generate wealth formation. A simple way to understand this is as friction to the speed at which capital flows through the system. This matters to every American, not just the wealthy, as McCain critics say. This matters to every American because if assets are not deployed, and or leveraged, then entrepreneurial activities are curtailed, and with this comes a reduction in jobs, and a decrease in wealth distribution, and most importantly to wealth concentration which makes the average American a indentured servant to the concentrated wealth.
McCain understands that we need alter wealth distribution in this country such that it benefits the middle class and grows it. He also understands that in a free society you do not accomplish this by confiscating another’s wealth and redistribute it to others on the government’s whim. This was the approach of the old Soviet Union. What we need to do is provide incentives for people to place their wealth into the system so that others can become wealthy in their own right.
For those that think but I just want a job, and this does not matter to you, more business creation, leads to more jobs, and in today’s world with equity participation, greater wealth.

2008 Sep 27 03:45 PM

[Obama is Bu...:]

Why does Seeking Alpha allow political commentators like Brad Delong to publish on an investment website?

Come on SA editors -- keep this partisan trash off your website or change the name to Seeking Politics

2008 Sep 27 04:01 PM

[jmkeynes:]

Excellent article

So, lets take a poll of Seeking Alpha journalists to see where they stand:

a) Corporate Socialist (Socialism for the Rich),

b) Free Fall Market Nihilist (the End is Near, Short Everything),

c) Plain old Democratic Socialist (we need a Swedish style bailout),

d) Other/confused

Brad is clearly in the democratic socialist camp, which is my favorite too.

I assume that everyone if familiar with Socialism for the Rich already. The Free Fall Market Nihilist position is described below.



The Rise of Free Fall Market Nihilism

The latest financial crisis in the US is forcing old economic ideologies to reinvent themselves. We're long past the old socialism versus capitalism dichotomy.

Many on both the left and the right will object that the $700 billion dollar bailout plan really amounts to Socialism for the Rich.

The left favors a traditional, democratic form of socialism. So, they tend to support the approach the Swedes took when their banks needed bailouts (i.e. give taxpayers an equity stake in the banks being bailed out).

Libertarians, however, are having a harder time of it these days.

Just as there are no atheists in fox holes, we're starting to find that there are no die hard Libertarians in times of financial crisis - unless, of course, you count those who are short the market.

True believers in libertarian dogma always want the government to stand aside regardless of the consequences.

But, there are also those "pragmatists" who can espouse either a Libertarian dogma or a Corporate Socialist dogma depending on their financial position.

If you and the corporation you manage would benefit from a government bailout, then opt for corporate socialism.

But, if you don't manage a company in need of a bailout then short the market and opt for Free Fall Market Nihilism.

Whereas market bubbles are fueled by self-fulfilling optimistic prophecies, market crashes are fueled both by self-fulfilling pessimistic prophecies and naive free market ideology.

So, during times of financial crisis, Free Fall Market Nihilists short the market and then also cynically espouse a naive libertarian ideology that firms, markets, and even entire economic systems should always be allowed to fail.

The Free Fall Market Nihilist's mantra goes as follows:

"Government intervention is always wrong. In the long run, free markets will always correct. So, bring on those waves of creative destruction: The greater the financial destruction the better. The world is coming to an end, I've shorted the market, and so should you!"

So, lets take a poll of journalists at the Economist to see where they stand:

a) Corporate Socialist (Socialism for the Rich),

b) Free Fall Market Nihilist (the End is Near, Short Everything),

c) Plain old Democratic Socialist (we need a Swedish style bailout),

d) Other/confused

2008 Sep 27 04:14 PM

[dw57:]

I think this is just as good a suggestion as the bail out. maybe better. the solution of doing nothing means that the great depression will become a foot note. the thought that some will survive is the same as those who were survivalists. they presume humans aren't social beings just because they aren't. and those who deride regulations are also reject criminal law. they exist for the same reason. people unfortunately are not inherently ethical beings. and for those who say do nothing. they must be expecting to survive under the dictatorship that will arise out of the mess that are in favor of.

2008 Sep 27 04:41 PM

[User 271458:]

Nationalization? Like Zimbabwe? Like Venezuela? This is the most ludicrous of all three options. Socialism has proved to be a spectacular failure, and Sweden since becoming more and more socialist over the last 40 years, has gone from strong growth to pure mediocrity. These classroom theorists are the types that push intill communism. From his article:

"grants the Federal Reserve Board the power to take any financial firm whatsoever with liabilities and capital of more than $25 billion that is not well capitalized into conservatorship,
requires the Federal Reserve Board to liquidate any financial firm in its conservatorship when it judges that the firm is insolvent (paying off in full or not paying off in full the liabilities of the firm at its discretion), unless
the Federal Reserve Board finds that preservation as a going concern is in the interest of the taxpayer, in which case Congress
grants the Federal Reserve Board the power to transform equity stakes in the firm into junior preferred stock at par value and then transfer ownership and custody of the firm to the Treasury,
requires the Federal Reserve to terminate conservatorship if the firm becomes well-capitalized once again."

In a nutshell: If the firm is profitable, the owners benefit. If it's about to take losses, then the taxpayer (that's you) pays. This invites for excessive risk taking (if you know you're going to bailed out for failure, you might take a few extra risks, eh)?

It is stunning that some people never seam to learn their history, and learn what a failure nationalization is. Like communism, it sounds good on paper, and some people are probably scratching their heads reading this, saying "wow! what a plan!" Uh huh.

2008 Sep 27 05:13 PM

[Reinko:]

What I constantly lack in all these articles around this bailout stuff that no author of what article has good insight in the real macro economical conditions.

Do you think 700 billion US$ is enough?

It is peanuts; simply the combined value of family homes will contract about 6,5 trillion US$ before long term affordability is restored again.

If house owners take 80% of that damage and the banks 20% then we are looking at 1.3 trillion in future damage stuff.

This 700 billion joke is just a joke.

With numbers like that it does not make much difference what model you choose to fight the problems...

2008 Sep 27 05:29 PM

[The Realist:]

Talk about the premise of an article making it worthless.

"It's time for the Democrats to pass a nationalization in the taxpayers' interest bill and dare Bush to veto it."

What a joke. Democrats want any plan that increases the size of government and pays off their NY banking friends. And no idiotic comments like the republicans are the party of the rich. That is just moronic. NY by size is an entire red state, it is just the concentration of blue in NYC and its suburbs that is so left wing that the entire state is always in the democratic camp. These are the democrat's constituents that give them money and keep them in power.

The Democrats can pass a bill today like Paulson's and Bush will 100% sign it. The reason that they have not done this is that they don't want the voters realizing what kind of hypocrites they are, always talking about soaking the rich to pay the poor but then when push comes to shove they send the poors' money to the rich.

This is a democrat's dream, pay off their money supporters and increase the size of government at the same time. I called Sen. Reid's office and was told he did not like the Paulson plan as written, he needed more governmental powers put into the plan to increase his fascist beliefs.

Now with all that said I like some of this plan, the fact that equity and bondholders have to pay for their mistakes. The problem is pretending that the democrats have the country's best interest at heart. What a joke.

2008 Sep 27 05:31 PM

[PK de C'ville:]

@Purl Gurl

You Wrote, "Oh my, Mr. Delong, you are a partisan leftist socialist, yes? "

And I write,

"Oh my, Purl Gurl, you are a partisan idiot, yes?

Not good to call people names. (Irony intended.)

2008 Sep 27 06:49 PM

[DougM:]

I think if you nationalize a firm that's not well-capitalized, you'll trigger a credit event that sets off all the CDS's that have been written on that firm. That would then cause more firms to fail, I suspect you'd end up owning all the firms. At least then the government could net out all the swaps across counter-parties. One question would be, if the FDIC takes over a firm, is it on the hook for the CDS's, or are those, like the debt of the failed firm, detrius to be squabbled over in bankruptcy?

2008 Sep 27 07:06 PM

[schminkie:]

2 things.

there are more than 3 fixes. use the mythical 700 billion to rebuild the infrastructure issuing private sector rfp.s with gov't loan insurance [use aig since we already own it] and/or cheap loans, subsidies, funds matching programs, any way to get the capital out there; capital infusion into the population, job and industrial expansion, as needed. once growth begins it would grow geometrically. who know maybe people will have the $$ to pay mortgages and even buy some of those inventoried houses. there's a thought.

2. an economic system must work in good times and in bad times and especially in bad times. remember free market capitalism? ...duh...
let the failures fail. invest the $$ where it will grow [hey capitalism! who'd a thunk it?!] and benefit the real economy much and the virtual derivative non-productive dead in the water economy little or not at all.

2008 Sep 27 07:14 PM

[schminkie:]

one thing more, why are 'we the people' being characterized as victims by gov't and media? i am sick and tired of patronizing bureaucrats. ' ...aw, you just don't understand high finance folks. now don't go thinking too much. you'll just get confused. let us experts take care of it ok? go have a beer and watch the game like good children. leave it to us'

out of this whole mess there is one thing true and proven. the experts having already failed in international proportions [again] are clueless.

2008 Sep 27 07:18 PM

[localglobal:]

The nationalreview.com interview by David Freddoso of John Shadegg -- see my website, to the left or google it -- raises interesting questions about words from Wall St. vs. facts from Main St. If local banks have plenty of money to lend, why should Congress care that huge credit issues for global companies now cost a few percentage points more than they have for the past few years? Why don't global companies just issue more equity (that could be purchased by congressional constituents looking for value) if they can't get decent terms from global debt markets? Especially since small and medium businesses that use local banks create the vast majority of new jobs and have been much more responsible than global credit merchants, why should the local constituents be punished for the failures of their global competitors? No wonder the framers called for dispersed representative national governance and limited national powers.

2008 Sep 27 08:05 PM

[dixie:]

You have either been in hibernation for 20 years or you are a screwball.

You say you want the folks that brought us Fannie Mae and Freddie Mac to be our commercial bankers, DMV style.

Canada will have a population explosion.

2008 Sep 27 08:32 PM

[jcrash:]

Kimberly, you can clarify all you want. But, why would I vote for someone that cannot put forth a clear agenda without external "interpretation?"

The guy won't even live to see the ramifications of 10% of his decision, and that is assuming he manages to live out a full term and not leave us stuck with the hillbilly soccermom he chose as a running mate.

I was considering voting for him until he made that running mate choice. If that is the type of decision he makes under pressure, I think we all know who we should elect.

2008 Sep 27 08:33 PM

[Alan von Al...:]

Personally, I like President Milf. But let's talk about Brad DeLong's "nationalization" proposal.

To be extremely brief, it's not. What he proposes in this article is Chapter 7 bankruptcy, managed by the executive branch instead of Federal courts. It is probably unconstitutional, but in any case it's obviously the right thing to do with insolvent firms.

2008 Sep 27 08:59 PM

[Steven Hansen:]

when an author insinuates or blatantly professes partisan politics - the point the author was making is destroyed.

i would like to point out that the actions by FDIC against WaMu are really nationalization - so in effect what the author is proposing is indeed being implemented.

2008 Sep 27 09:08 PM

[Diane Ritter:]

How about "the WaMu option"? That seemed to work stunningly well. The stockholders and bondholders lost a lot of money, but everyone else came out smelling like a rose. All of the real assets of the bank were transferred unimpared to another bank. No lose there, in fact a clear gain, since they will now be managed by someone competent and prudent. No loss to the depositors, thanks to the FDIC. No loss to the economy, in fact, again, a clear gain, since JPMorgan's balance sheet is healthy enough that they are still making loans. No loss to the taxpayer. No loss to anyone at all than the stock holders and bond holders. They got left holding the bad, which is exactly who should have been left holding the bag. End of story.

Why shouldn't the exact same approach be used for all the other banks who balance sheets smell to high heaven? Why do we need a bailout and mega taxpayer funds to re-capitalize these banks? Let them die, and more prudent and competent managers will come in and pick up the pieces immediately. Just like magic the bad debt is no longer a problem. It isn't a problem because it has been repriced by the bankrupty right down to what someone is willing to pay for it.

All we need to do is to tell the FDIC to get the lead out, instead of waiting month after excruciating months for the problem banks to slowly, slowly die. Get it over with. As soon as they do, the economy will start to recover.

Or we can use the Japanese approach and spend ten years propping up these dying banks with larger and larger infusions of public money. We all know how well that worked out.

2008 Sep 27 09:15 PM

[DougM:]

WaMu probably wasn't a swaps player. I think they're deathly afraid of either a swaps player going down, or a firm that's the subject of a lot of swaps going down, because any such event threatens to trigger the swaps bomb.

2008 Sep 27 09:30 PM

[madasiwannabe:]

Amazing how Kimberly Peacock can so clearly articulate a position that McCain cannot. After listening to him the position I can definitively say he has is that against Obama. What was his position when he was involved in the Keating 5 scandal? How was that looking out for small business and taxpayers?

Nationalization worked great for the GSE's. A lot of shareholders lost their money, but not one nickle will go towards fixing Fannie or Freddies financial woes. It all just changed hands from longs to shorts. Net result is the taxpayers will now have to pay back the money the shorts pocketed and then figure out how to pay for the losses.

WM worked out great too. JPM got 310 Billion in assets for free. FDIC got 2 Billion for their trouble and the shareholders transferred their money to the shorts. Net result is 8 billion worth of debts will not be paid back, and JPM will sell the 30 Billion they just wrote down for 50 cents on the dollar and make 15 Billion for their trouble.

Doing nothing, means all of the US assets will change hands and we the American people will end up with nothing. Sounds like everything from here is a little too little and a little too late. Thanks Hank and Ben for your bringing your experience to DC. Without you we would have never been able to find our way over the cliff so quickly.

2008 Sep 27 10:06 PM

[Absolved:]

Pardon me, but you're an idiot! The Federal Reserve is part of the problem! The banksters now want to pass their garbage off onto the American taxpayer...yeah right, not going to happen. Businesses fail all the time. Sure, it will hurt. They fostered instituting the CRA which led to their current situation, they fought being regulated, they forced some of the trash onto Fannie and Freddie who also fought being regulated, and now the music has stopped and they want the taxpayer to create a chair for them. NO DEAL!

2008 Sep 27 11:58 PM

[retrader:]

Investment advice for the remainder of 2008 and 2009 :
Start collecting any firewood and burnable materials for heat. Locate the nearest soup kitchen in your community. If you don't go to church, start going, as some serve up the better meals. Have a nice weekend
( they might start becoming few and far between this winter ).

2008 Sep 28 02:17 AM

[fatcat:]

Why do people keep saying Wamu was a clean deal...what do you think happens to all those crappy Cal. motgages on wildly overpriced houses?

This deal was an asset "gift" to JPM and a liability to everyone else..

2008 Sep 28 04:05 AM

[whisperonth...:]

While all you people discuss the politics and possibles, I'm glad I sold WM and kept JPM, even if it was losing for a while. I guess I just don't see letting the government take over the banks, and from what I saw of the debates, at least McCain had ideas of programs to cut, whereas Obama only had programs that he wanted to increase. How did people survive before all these "I'm poor" subsidies? Since when was it a law that everyone deserved to have as much as their neighbors? You get what you earn, plain and simple. The same should be true for the banks. If they don't earn, they should go under. Why bolster a loser when you could instead support a winner?

2008 Sep 28 08:25 AM

[BrunoT:]

The author shows he is ignorant when he claims we "did nothing" during the great depression. Oh yeah? What are price controls and wage controls? The govn't action prolonged and deepened it.

With "experts" like this no wonder we're in deep kimchee.

2008 Sep 28 12:09 PM

[Smalltownba...:]

Thank God you are no longer in the White House advising anyone!

2008 Sep 29 09:12 AM