Why Neither Nationalization Nor a New Tarp Can Fix Our Finances

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Mr. Livingston teaches at Rutgers, the State University of New Jersey. The arguments of this piece are drawn from his new book, The World Turned Inside Out: American Thought and Culture at the End of the 20th Century (Rowman & LIttlefield, 2009). Next year he will be a fellow at the Cullman Center for Scholars and Writers of the New York Public Library, working on a biography of Horace Kallen.

The banks are neither loaning nor investing.  They’re sitting on idle reserves provided to them by the Treasury’s disbursement of funds from the Troubled Asset Relief Program, or they are waiting for directions from their ostensible supervisors in the federal government. 

Why not then just go ahead and nationalize them, thus forcing them to do their job of moving money from savings or deposits to productive investments, of converting idle surpluses to working capital?   

Because nationalizing the banks means replacing their management with public sector personnel whose purposes are not limited to mere profitability narrowly construed as shareholder value in the form of dividends.  In the near term, that move destroys their publicly traded value in the stock market and thus leaves taxpayers holding the bag by socializing the attendant losses.  In the long term, and this is more important, that move threatens the central principle of American politics—the supremacy of society over the state.

Reprivatization of the banks is possible, of course, as proved by the American experience with railroads after World War I and with steel and autos after World War II, and, at a much less convincing level of comparative history, by the Swedish example from the 1990s.  But in view of the catastrophic effects of the bankers’ recent binge, why would anyone want to return control of the economic future to people whose idea of a public good is an officious doorman?

What about the alternative to nationalization, which the Obama administration will unveil this coming week?  As Martin Wolf of the Financial Times pointed out last month, a renewed TARP treats the banking system as if liquidity rather than insolvency is the central problem.  Buying some portion of the banks’ toxic assets with the remainder of the money authorized by Congress won’t make them solvent, and won’t equip them to lend to businesses or individuals.    

What then is to be done about this double bind, which should worry conservatives, liberals, progressives, and socialists alike?  Ask the question in a more practical way—is there a quick financial fix available?  Everybody from Greg Mankiw to Paul Krugman seems to think that the first step in restoring confidence and credit is to make the banking system work again; they have different reasons for insisting on this priority, but their agreement is uniform. 

This odd consensus derives, of course, from the newly conventional wisdom first peddled by the arch-monetarist, Milton Friedman, who claimed that the Great Depression was prolonged if not caused by the Fed’s mistakes and cured after 1933 by the expansion of the money supply.

But what if there is no quick financial fix?  What if recapitalization of the banks won’t work because the value of their toxic assets must outweigh any federal infusion of funds, and so must make any loan too risky?  What if the zombies aren’t coming back to life, no matter what we do?  And what if nationalization of the banks contains more long-term costs than short-term benefits?

There’s a good answer residing in the experience of a comparable moment—during the Great Depression and the New Deal, from 1933 to 1937.  These were the years of economic recovery, when national income and industrial output doubled, thus regaining the levels of 1929 after being halved from then until 1932.  Did the banks lead the way to this remarkable recovery?  If not, what was the nature of the financial fix?  Or was there such a thing? 

A glance at the relevant reports of the Comptroller of the Currency tells us that the banks sat out the recovery.  The summary Table 47, “Total Assets and Liabilities of National Banks, June 1933-June 1937,” Report of the Comptroller of the Currency 1937 (Washington: GPO, 1938), pp. 488-94, shows that during the recovery, total deposits increased 52 percent, holdings of government securities increased 57 percent, and (idle) reserves held with Federal Reserve banks increased 140 percent.  Meanwhile loans and discounts—that is, the extension of credit to businesses and/or households—increased a mere 8 percent.   

So there was an economic recovery from the depths of the Great Depression with no financial fix, or rather with almost no participation by the banks, except of course that.they bought the government securities that financed net contributions to consumer expenditures out of federal deficits.  And no nationalization, either.  How is that possible?

The short answer is that the Reconstruction Finance Corporation, which was created in 1932 and authorized in 1934 to lend directly to businesses, bypassed the banking system and became the lender of first resort to businesses large (over $ 1 billion to the railroads) and small (most of its loans were under $100,000).  The volume of its loans and discounts during the four years of recovery was roughly equal to that of the national banks.  Its loans to strapped cities, states, and agricultural cooperatives far exceeded those of national banks.    

The way to deal with the current crisis short of nationalization may, then, be to bypass the moribund banking system with a new RFC capitalized with the remainder of the TARP and other funds authorized by Congress.  Let it augment and complete the Fed’s efforts to sustain the market in short-term paper, and let it, meanwhile, set up shop as the lender of first resort to businesses large and small, particularly small businesses with the prospect of making new hires.  When the national banks have bought enough government securities to finance the deficit spending we’ll need to recover, perhaps they can sell their toxic assets in their favorite place—the free market—and still have some reliable, liquid assets to offset their inevitable losses.

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    James Livingston - 3/26/2009

    Under Bernanke, the Fed has expanded its powers so fast and so far beyond its original mandate that it may well be functioning already as an ad hoc RFC. For an itemization of some of its new initiatives, see Bernanke's speech at the LSE as summarized at my blog, www.politicsandletters.com, and Matt Taibbi's populist rant at Rolling Stone 3/19/09, "The Great Takeover," which could have been written by Ron Paul or Tom Watson, just yesterday or in 1892. And always remember the plaint of Edward Bellamy in Looking Backward (1887): "Money was the sign of real commodities," he said through Dr. Leete in that novel, whereas "credit was but the sign of a sign."