Nationalize the Banks or Just the Losses?

Paul Krugman’s column yesterday deserves not to get lost in the holiday/inauguration shuffle

He fires back at the “bad bank” TARP-lite scheme being put forth by people like FDIC Chairwoman Sheila Bair, who was promoted by Krugman’s colleague Joe Nocera in a front-page column on Saturday. Here’s Krugman:

Instead, they’re reportedly gravitating toward a compromise approach: moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” that would resemble the Resolution Trust Corporation, but without seizing the banks first.

Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, recently tried to describe how this would work: “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?

“Fair value” would, of course, mean paying too much for crappy assets and socking the taxpayers with the hundreds of billions of dollars in (additional) losses.

As Krugman says, many of these banks are insolvent and the only way to fix that with a plan like Bair’s is to way overpay for these junk assets. In the process, it will bail out the banks’ shareholders. But if any bankrupt company’s shareholders deserve to lose their entire investments, it’s these.

But not everybody thinks that way. Felix Salmon over at Portfolio points out the NYT’s Joe Nocera making an appalling nod to the banks about nationalization. Here’s Nocera:

Though this cuts against the American grain — and leaves shareholders with nothing — it does make it easier for the government to get the banks back on their feet, and presumably, once the crisis ends, to hand them back to the private sector.

Nocera, presumably, isn’t taking that side. But he’s giving too much credence to an utterly bogus argument. Salmon takes care of this nicely:

I’m not sure what the American grain is, but it’s hard to see how nationalization cuts against it while a trillion-dollar bailout doesn’t. And yes, shareholders of insolvent banks should be left with nothing: that’s capitalism, that is.

Unless they’re lucky enough to get other dumb banks to buy them out, like Merrill Lynch was with Bank of America. And B of A and Citigroup are who we’re really talking about here. I haven’t understood why the press wasn’t taking a more skeptical approach to the Bank of America story, which it essentially played along the lines of “CEO Ken Lewis Saves the Day”.

In part, the answer is because of the business press’s institutional bias—yes, bias—toward deals. But the press is also oriented toward finding a narrative, sometimes at the expense of sound reportorial skepticism, which is what I think happened here. It was always too neat a story that “healthy” Bank of America would swoop in and clean up Countrywide’s mess and take on Merrill Lynch’s, too. But I digress.

It’s pretty clear a significant number of other banks are insolvent, as Krugman and Salmon say. The system and thus the economy won’t recover until these “zombie” companies are culled. It’s hard to see how they’re wrong that the fairest way to do that is to nationalize them, wipe out the shareholders and, while we’re at it, clip some of the junior debt holders, too.

That’s the real American way: the vicissitude of the market, this time with a government push. Creative destruction, as they say.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.