Wharton's Take on Bank Nationalization

Updated from Feb. 23

After a generation of increasingly relaxed regulation of the financial services sector, the very concept seems stunning: Nationalization of banks in Europe and the United States.

But with many global banks still teetering on the brink of insolvency -- even after rescue efforts that have included multi-billion dollar infusions of capital and other forms of assistance -- a growing number of economists now argues that government takeovers of the most deeply troubled institutions, at least temporarily, may be the only remaining solution.

In the U.S., former Fed chairman Alan Greenspan has unexpectedly joined a list of notable financial experts who believe some banks may have to be nationalized temporarily. Additional surprising converts include prominent Republican politicians such as Sen. Lindsey Graham of South Carolina and former presidential candidate John McCain.

Many Wharton faculty also agree. Among them is Wharton finance professor Franklin Allen, who argues that a temporary nationalization of the affected banks is the only way to remove the top executives who helped trigger the financial crisis, while ensuring that the interests of taxpayers are valued over those of stockholders and bondholders. "This is not something the government should be doing in the long run," says Allen. The banks should be nationalized "for however long it takes for things to get back to normal. I would imagine that would be less than three to five years." Like other advocates of bank nationalization under the current circumstances, he points to the example of Sweden, which nationalized its banks during a crisis in the early 1990s and for the most part privatized them again once they had been stabilized.

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The U.S. is not the only Western economic power in which recent talk of bank nationalization abounds. Ireland nationalized Anglo Irish Bank in January and has spent some $9 billion to recapitalize Bank of Ireland (IRE Quote) and Allied Irish Banks(AIB Quote). In Berlin last week, the government said it would prefer to take a majority stake in Germany's struggling Hypo Real Estate Holding rather than nationalize the property lender. "Nationalization is only an option after attempts to take a majority stake have failed," a government spokesman said. "Everybody agrees that nationalization can only be a measure of last resort if it's necessary for the stabilization of financial markets and other, less severe solutions" have been exhausted.

There has also been speculation -- frequently denied by U.K. Prime Minister Gordon Brown -- that the British government aims to nationalize Lloyds Banking Group (LYG Quote) or Royal Bank of Scotland (RBS Quote), in which it holds stakes of 43% and 70% respectively. Just a year ago, the U.K. nationalized Northern Rock, one of the first banks to suffer catastrophic losses from its exposure to securitized subprime mortgages in the U.S.

European experiments with bank nationalization have essentially treated it as a temporary measure, to be reversed when the financial system returns to normal. In contrast, Asian countries such as India and China have adopted a different nationalization model -- which has had results that are often negative. As governments in the U.S. and Europe ponder their own rescue strategies for banks, these experiences could serve as cautionary tales of the risks involved in nationalization.