Updated from Feb. 23After 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.
That once-radical position is finding some support. According to Allen, the biggest problem with the current bank rescue plans is that they have not removed the executives who caused the crisis, and have allowed them to continue to collect large salaries, bonuses and other perks despite taxpayer outrage. "We've got all this money invested and no control over what they're doing at all," Allen notes. "The classic example is what happened with the bonuses at Merrill Lynch, which gets dealt to Bank of America and says that they need $20 billion. The government says 'yes,' and then they turn around and hand out $4 billion in bonuses."
the government put the banks back in good shape -- it was a better way to proceed." Allen and other experts note that Sweden's comprehensive approach was much more successful than Japan's woeful performance during its so-called "Lost Decade" of the 1990s, when the government's intervention to help out banks was seen as too piecemeal and not dramatic enough to end a prolonged slump. Wharton finance professor Itay Goldstein has concerns about bank nationalization in the U.S. Still, he adds, the initial stage of the federal rescue plan showed how hard it is to attack the problems at U.S. banks without the kind of large-scale coordination that comes from a central government. He said that individual banks are reluctant to make loans during the current crisis -- even after the initial cash infusion from Washington -- because they worry that borrowers will default as the economy drifts deeper in recession. "There's also a coordination problem," he says. "If you feel that banks are not seeing the full picture of their impact on the economy as a whole ... taking over the banks could be justified. The costs are huge -- it is almost impossible for the government to take over so many big banks and actually control them. I don't know if the government has the personnel for that." "While we're not happy with the CEOs of the banks, I don't think many people want the government and a bureaucracy running the banks," says Wharton finance professor Jeremy J. Siegel. "You could get rid of all these CEOs and say that you're going to get a new board, but there's a feeling that you want to keep the banks in the private sector."
Siegel believes the Obama administration should continue along its current path, which aims to separate the banks' good assets from their toxic holdings, even though he acknowledges that developing such a plan is difficult. He also argues that any additional infusions of taxpayer money should ensure that the banks' bondholders "take a haircut" in addition to the losses already felt by stockholders who have watched the value of their shares plummet. Allen says the current response to the economic crisis has been characterized partly by the amount of coordination involving Western governments. He notes that the U.K. has been reluctant to go the full nationalization route because of lessons that it learned during the 1970s, but he expects that stance to change soon. "They were reluctant," he says," but now they already own 70% of RBS, so I think they'll do it." From the late 1960s through the early 1980s, the British government nationalized nearly a dozen industries, including auto manufacturers, utilities, transportation and aerospace firms. Many of them have since returned to private control. Mexico also managed what is generally viewed as a successful, temporary nationalization of much of its banking system following the peso crisis of the 1990s. But critics of bank nationalization contend that while this radical solution may look like a speedy panacea for the financial crisis in the U.S., history has not been kind to most efforts -- especially a wave of such efforts by socialist-leaning governments in Europe and elsewhere in the generation following World War II. Many of these efforts failed for the same reasons -- lack of competition led to inefficient bureaucracies as well as corruption and bad decisions based more upon politics than upon sound business practices.
Since the current administration came to power in China in 2003, policy towards state-owned banks has changed drastically, and reform of their shareholder structure (or privatization) has begun. The first step was a massive injection of state funds: The banks' non-performing (NPL) loan ratio was widely believed to have stood at 40% or more, but the central government had written off almost all of their bad loans by the end of 2003. A sell-off to "foreign strategic investors" (mainly international financial institutions) followed, with a 20% cap placed on single foreign ownership and a 25% ceiling on cumulative foreign ownership of individual banks introduced before the banks were floated at home and abroad. But banking privatization remains highly controversial in China. Fierce debates have raged among academics, particularly regarding pricing of shares sold to foreign investors, and the favoritism shown them over domestic investors. However, China's authorities have pushed forward resolutely with reform. By the end of 2007, China had 24 banks with more than 30 foreign strategic investors sitting on their boards. Over one-sixth of the Chinese banking system is now foreign controlled. Despite the debate on valuation and fairness in the privatization process, an improvement in China's banking industry appears evident. Following their partial privatization, banks have introduced governance structures to transform themselves into modern financial institutions, and the NPL ratio has fallen from 30% a few years ago to single digits today. Some observers also comment that the banking environment in China has changed radically over the past 10 years, with better regulation and supervision, better macroeconomic policy making, better internal controls and better borrowers. Due to its limited exposure to the international capital market, Chinese banks have not been impacted severely by the recent global crisis. In early February China's big commercial banks, the Industrial and Commercial Bank of China, China Construction Bank, and Bank of China (ICBC, CCB and BOC) ranked as the top three banks globally by market share. On June 17, 2005, the announcement that Bank of America would purchase a 9% stake in China Construction Bank for $3 billion -- the most expensive banking acquisition in China's history -- made headlines throughout the global financial media. Jonathan Anderson, chief economist at UBS Asia, commented at the time that it was a win-win strategy for both parties. He was right. On Jan. 7 of this year, Bank of America, under financial strain, sold 5.6 billion Hong Kong-listed shares in CCB at a fixed price of HK$3.92, reducing its stake in the Chinese bank from 19.1% to 16.6%. Bank of America made a profit of around US$1.1 billion from the sale based on the price of the shares at the time of CCB's IPO, according to the Financial Times. On the other hand, although Chinese banks have performed strongly in recent years, their ability to manage risk has not been tested, notes Qian Jun, a finance professor at Boston College. "Most of the Chinese banks haven't really experienced any true financial crisis, so they have not been tested in the areas of risk management and balancing between financial innovations and generating profits," he says. As the experiences of these countries indicate, bank nationalization is hardly a silver bullet that can solve banking problems forever. As consensus grows among U.S. and European economists in favor of nationalization, it may help them to keep these risks in mind. For more information about Knowledge@Wharton, please visit knowledge.wharton.upenn.edu.