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Nationalize the banks II

January 24th, 2009 · 2 Comments

We wrote last week that it would probably be best to nationalize the banks. We have some additional arguments..

And these additional arguments do not come out of the Communist Manifesto, or something like that. They come from Willem Buiter, a very clever (and very sympathetic, we’ve actually had the pleasure to meet him a couple of times) Dutch economics professor (who works mostly in London).

In our article last week we already argued that the incentives were all wrong, bank managers faced very strong temptations to take on way too much risk, and they were doing it with other people’s money.

They could hardly lose, as their bonuses were kept in tact and are largely independent on performance. They amassed fortunes, and they kept doing that until very recently (and some are still doing it).

Now, despite really very large bail-out money from governments, banks are not lending. Guess why.. Once again, the incentives are all wrong..

Banks are not fond of taking Government money as this usually (although not always) has negative effects on their salaries and bonuses, so why would they? To avoid having to take Government money, they curtail all risk, not exactly a way to stimulate banks to lend again.

Even if taking public money has become unavoidable (otherwise the bank would go under), the incentives are still wrong. Rather than lending money out, the banks use the money to strengthen their balance sheets in order to get of the public infuse as soon as possible.

Because the sooner they are off the public purse, the sooner they can revert to their old ways (read: salaries and bonuses).

Markets work, but if they are badly regulated, they can produce perverse incentives, and the financial sector is a prime example, even now.

Nationalizing is one way, another way, suggested by Xavier Vives, a Spanish economist, is to end the limited liability of banks, which would the bets that bank executives play with other people’s money a little less one-sided. If they could actually lose themselves, they would become a lot more careful..

Tags: Credit Crisis

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