The Bubble of Bearishness, Part 2: Banks

So we were on the brink of whether banks would or could be nationalized. In reality, nationalization would have nearly destroyed almost every insurance company, pension fund, endowment and retirement plan in the nation.

Consider your losses in the market and multiply them by two. Furthermore, the outcome of nationalization was unknown, and recent government interventions did not bode well. Fannie Mae, Freddie Mac and AIG were under Uncle Sam's stewardship for six months with no success.

Nationalization would have been the worst pro-cyclical response to a crisis in history. We are all lucky that Ben Bernanke took Milton Friedman at his word and believed that more effort should have been made to save the banks during the Great Depression. Instead of nationalizing, the government effectively nationalized the banks' risks without wiping out the equity owners or impairing the creditors.

When economists think of the traditional ways to respond to crises by wiping out equity holders, they fail to recognize two things. First, in a systemic risk situation, the priority is to halt the domino effect of the panic. Second, the landscape of the investor class has changed dramatically over the last three decades.

In 1980, 6% of households owned mutual funds, today, 45% do. In 1980, 3% of household assets were held at investment companies; today, it is 19% (that is where our savings rate went).

Nationalization would not have halted the domino effect of the banking system collapse, it would have hastened it. In addition, it would have further damaged the consumer and the American public. The Federal Reserve and Treasury wisely recognized (thank you, Milton Friedman) that there were more options than the "traditional way" to respond to a systemic event.