Bank nationalization will fail, too

No good will come from government ownership or control of banks (“nationalization”). Banking is a business. Government is an instrument of blunt force. Were government to own or control banks, it would not be able to tolerate an outcome which is essential to the health of any market: failure. Government managers would careen from strategy to strategy, with each change in direction requiring more taxpayer support and greater restriction on any competition that might derail their plans. Nationalization of banks will exacerbate, not ameliorate, the current catastrophe in financial markets.

Nationalization fails to address the root causes of the banking disaster: speculation by banks with FDIC-guaranteed deposits and corporate ownership forms that misalign the interests of bank managers with those of shareholders and creditors.

As for FDIC’s deposit guarantee, we have learned nothing from the thrift debacle of the 1980s or those who have objected at every step in the implementation and subsequent expansion of government deposit guarantees. Even the warnings of government economists about the moral hazards implicit in FDIC guarantees have been ignored.

Similarly, with disastrous consequences we have ignored the warnings of countless economists and legal theorists that banking is incompatible with corporate and other limited-liability-ownership forms. For good reason corporate banking was illegal in the United States until the middle of the 19th century. It is no accident that the only solvent bank in the United States is Brown Brothers Harriman & Co. – a general partnership.

The combination of government-guaranteed deposits and corporate banking was a recipe for the present disaster, as many said it would be.

Government managers can do no better than current bank management with the putrid practice of funding illiquid or otherwise risky investments with demand deposits backed by the full faith and credit of the U.S. government. Government managers cannot predict the future any better than private managers but may be worse at such predictions.

If taxpayers are to be the ultimate guarantors of bank deposits, then such bank deposits should only be invested in government bonds on a matched-duration basis. No other investment strategy will insure bank solvency. Of necessity, the returns on such deposits will be low. Those seeking higher returns should be free to speculate in banks of their choosing, but without a government guarantee as to the outcome of such speculation.

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