TOPICS > Economy

As Banking Woes Grow, Debate Over Nationalization Intensifies

February 24, 2009 at 6:20 PM EDT
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As turmoil continues in the U.S. banking industry, speculation is intensifying over whether the government should take larger ownership stakes in banks. Columnist Paul Krugman and former FDIC chief William Isaac weigh the pros and cons.
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JIM LEHRER: Next, the new big debate over nationalizing American banks, and to Judy Woodruff.

JUDY WOODRUFF: The question was posed to Federal Reserve Chairman Ben Bernanke today. It’s been raised in Washington and on Wall Street for weeks, and we heard it come up in Gwen’s conversation just a moment ago. Should the federal government take over troubled banks?

Well, we get two different views. Paul Krugman is a professor of economics with Princeton University and a columnist for the New York Times. He won the Nobel Prize in Economics last year.

And William Isaac was chairman of the Federal Deposit Insurance Corporation in the 1980s. He oversaw the government’s seizure of the country’s seventh-largest bank at the time, Continental Illinois bank. He’s now chair of the financial services consulting firm, the Secura Group of LECG, which works with many banks.

Gentlemen, thank you for being with us.

And, Paul Krugman, to you first. Just about everybody in the Obama administration is saying they’re not talking about nationalization of the banks. Do you believe this is something that’s seriously under consideration?

PAUL KRUGMAN, Columnist, New York Times: Yes. I mean, what are they going to say? At a certain level, you don’t say, “Well, we’re thinking about it,” because that might precipitate a collapse in confidence that might, you know, cause it to happen right away.

And they have to be aware. They have to be aware that, since they are propping up the banks — you know, the major banks in the United States are already wards of the state. They already survive because there’s an implicit lifeline. There’s basically the federal government standing behind their liabilities, saying, “We’re not going to let these things fail. Don’t be afraid of doing business with them, because you know Uncle Sam will come to their rescue.”

They know there has to be a point, just as there is with small banks which get in trouble, there might be a point where they have to take over the banks. Now, they are obviously not ready to do it just yet. But they’re clearly considering it.

And let me just say one important thing, that we do — you know, we nationalize two banks a week. The Federal Deposit Insurance Corporation takes over temporarily two banks a week on average because of problems with the banks. This is not something that is qualitatively different from what we do all the time. It would be quantitatively different, because we don’t take over trillion-dollar banks every week, but these are — you know, this is something we do, do all the time.

JUDY WOODRUFF: And the conversation here, we should point out, is about those 20 biggest banks in the country…

PAUL KRUGMAN: That’s right.

JUDY WOODRUFF: … the ones with assets over, what is it, $100 billion.

PAUL KRUGMAN: That’s right.

Defining bank nationalization

William Isaac
Former Chairman, FDIC
They're terribly complex. I don't know who would run them. I don't know who's going to buy them once the government decides to divest them. And they're definitely going to shrink, if they are nationalized. The markets won't support them.

JUDY WOODRUFF: But help us quickly understand, how do you define nationalization? When does helping and overseeing a bank become taking it over?

PAUL KRUGMAN: Well, the real question is, what happens to stockholders? Do you just give the banks some aid and then, if it recovers, that's a big gain for the people who own stock in it?

Or do you step in and say, "OK, we're going to keep this bank in existence, but the stockholders are now cleaned out. For the moment, the U.S. government is the owner of the bank. We're going to clean it up. We're going to get bad assets off the books. We're going to pay off some debt, and then we're going to resell it, but, you know, the upside now belongs to the taxpayer"?

And there is a bit of a fuzzy line. When you have something like AIG, the insurance company, which is 80 percent owned by the taxpayers, has it been nationalized or not? And that's a little bit unclear.

But that's the question. The question is, are we going to have a "heads the stockholders win, tails the taxpayers lose"? Or are we going to have a situation in which basically the taxpayers absorb the upside as well as the downside?

JUDY WOODRUFF: William Isaac, do you agree generally with that definition of what constitutes nationalizing the banks? And why do you think it's a mistake?

WILLIAM ISAAC, Former Chairman, Federal Deposit Insurance Corporation: Well, I would define "nationalization" as when the government seizes control of the ownership and the operations of a bank. And that's what we did in Continental. We took 80 percent of the stock immediately, and then had the ability to go to 100 percent, depending on our losses, which ultimately happened. We wound up with 100 percent of Continental.

And we controlled the bank. We replaced more than half the directors. We replaced the senior management. They couldn't do anything in terms of major decisions without our consent.

And we're not talking about something temporary when we deal with a big bank. In Continental, which was a relatively small bank compared to the big banks we're talking about today, it had less than 2 percent of the banking assets in the country. The top 10 banks today control over two-thirds of our banking system.

We told Continental -- we required it to shrink in half within three years, and we had to hold it for seven years. The FDIC didn't complete its divestiture of that bank for seven years. We can't afford to do that in our banking system today with these really large mega-banks.

And they're terribly complex. I don't know who would run them. I don't know who's going to buy them once the government decides to divest them. And they're definitely going to shrink, if they are nationalized. The markets won't support them.

And so you're talking about shrinking maybe two-thirds of the banking system in half? That's exactly the wrong medicine in the economy we're in today. We need our banks to grow; we need our banks to start lending money. And that's not going to happen if we nationalize them.

And the other thing, Judy, I would tell you is we're not going to be able to stop at a bank or two. The SEC is still not regulating the short-sellers, and they're going to attack one bank, until they score some kind of a victory and get the stock down to zero, and then they're going to attack the next one and the next one and the next one.

Current system 'not working'

Paul Krugman
Princeton University
These banks are already receiving huge infusions of taxpayer money. They're already being supported. They're already crippled in terms of their ability to support the economy.

JUDY WOODRUFF: Well, let me come back to Paul Krugman on your original argument. You heard what he said, that he's asking, who would run these banks? Who's going to buy these banks when the government gets through with them?

PAUL KRUGMAN: Well, you know, we will find buyers. There are people out there with money. To some extent, they can actually simply be, you know, set loose.

I mean, that's something that's going to be -- clearly, it's not easy. Obviously, it's not easy. Now, the Continental thing went on for a long time, longer than it should have.

But, you know, the main thing to understand here is that we're running out of alternatives. We're not saying, "Oh, here's a bank. We just don't like it in private hands. We're going to seize it." These banks are already receiving huge infusions of taxpayer money. They're already being supported. They're already crippled in terms of their ability to support the economy.

The question is, if we're going to pump in more money, how can we do that? How can we do that without it being simply being a gift basically to the same people who got us into this problem in the first place? That's why we're talking about a government takeover.

It's not out of some belief that, you know, nationalized banks are a wonderful thing. It's because we have to do something to prop up these institutions. And the way we're doing it now is not working.

JUDY WOODRUFF: William Isaac, what about that? Once the taxpayers essentially make such a huge investment in these banks, shouldn't they have a say over how they operate?

WILLIAM ISAAC: Well, the federal government has a lot of say in how banks operate. All these big banks have scores of resident examiners who live there. I mean, they're there every day. They go to all the committee meetings and the board meetings. The government has a huge say in these banks, particularly when they start suffering some problems and are taking taxpayer money.

I couldn't disagree more with the statement that these banks are insolvent or in need of a takeover. They're not. They're suffering through a very difficult economy, and, frankly, they're holding up pretty well.

I think those banks today are in better shape than the banks that we dealt with in the 1980s. We had 3,000 banks fail in the 1980s. And if we had -- if we had had mark-to-market accounting -- and that's where the SEC requires these banks to mark down marketable assets to whatever the current market price is -- if we had had that in the 1980s, every one of the major banks would have failed, absolutely.

And these banks are under very difficult circumstances, and I think they're holding up pretty well. They do need some help. We've got to help them get through this period. And the way to do that is to keep on putting capital in.

I'm not worried about subsidizing shareholders. My goodness, the shareholders of Citibank, for example, have gone from $300 billion in market cap to maybe $5 billion or $10 billion today. They've suffered a lot of pain, and those shareholders are you and me. We all have them in our 401(k)s. They were conservative investments.

Banks to be assessed individually

Paul Krugman
Princeton University
If you want to believe that the banks are in fine shape and they just need a little bit of help, well, you know, there's not much I can do to argue with that, if that's your point of view.

JUDY WOODRUFF: What about that?

WILLIAM ISAAC: I think we're way too focused on the shareholders.

PAUL KRUGMAN: Yes, well, this is the problem. If you're going to -- right, the shares are not worth very much now. But if you pour in lots of money, then maybe they -- you know, the gains accrue to them.

Look, again, actually, the 3,000 banks that failed in the '80s, yes. And what did we do? We took them over and then we re-privatized them, which is the way you always end up dealing with these things.

If you want to believe that the banks are in fine shape and they just need a little bit of help, well, you know, there's not much I can do to argue with that, if that's your point of view.

But we have a mechanism now. One of the best things that the Obama administration has announced is that they're going to do these stress tests. They're going to actually go and look at the banks, look at worst-case scenarios, look at whether they seriously are in danger. I think no one will believe it if they say that none of them are.

This is not -- if the banks were in as good shape as Mr. Isaac says, we wouldn't be in the problems we're in. You know, this is -- to argue that it's all because those nasty federal regulators are forcing them to do mark-to-market accounting, come on. This is not what's actually happening in our banking system right now.

Short-term takeover difficult

William Isaac
Former Chairman, FDIC
Now, as far as a short-term takeover, there's no such thing. You take these things over, you're stuck with them for a long time. Mexico had to stay with them for 17 years.

JUDY WOODRUFF: William Isaac, what about this notion of a short-term takeover, that it is something that would be done as an emergency measure? Because that does seem to be coming into the conversation more and more now.

WILLIAM ISAAC: Well, let me deal with that in a second, but, first, I want to address -- Paul really misquoted me. I didn't say these banks are in fine shape. I said they're in better shape than the major banks in this country were in the 1980s. And I'll guarantee you they are.

Every one of the major banks, if they had had to follow mark-to-market accounting in the 1980s, would have been insolvent, and clearly insolvent. So what I'm saying is that these banks are doing relatively well in a very difficult environment.

Of course they need help. And mark-to-market accounting has destroyed $600 billion of capital in the banking industry, which is $6 trillion of lending capacity. And it's been a major, major cause of the crisis we're in.

Now, as far as a short-term takeover, there's no such thing. You take these things over, you're stuck with them for a long time. Mexico had to stay with them for 17 years. They nationalized 80 percent of their banking system, and it was a total mess after 17 years of government ownership.

JUDY WOODRUFF: We're going to have to leave it there. Paul Krugman, unless you've got one-sentence response...

PAUL KRUGMAN: We can do better.

JUDY WOODRUFF: All right. Gentlemen, we are going to have to leave it there. We thank both of you.

WILLIAM ISAAC: And we will, Judy.

JUDY WOODRUFF: OK. William Isaac, Paul Krugman, thank you both.