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The banking crisis: Is nationalization the only way out?

Secretary Timothy Geithner plans to pump $1.5 trillion into failing banks, yet experts say that major U.S. banks already have $2 trillion in bad debt, and future losses in the financial system might raise the amount to as much as $7 trillion.<

The U.S. banking system is in “a death spiral,” said Matthew Richardson and Nouriel Roubini in The Washington Post, and only an “all-out government takeover” can prevent a complete collapse. Economists and banking experts are starting to whisper that Treasury Secretary Timothy Geithner’s latest bailout plan, to pump $1.5 trillion into failing banks, is too little, too late. The International Money Fund, Goldman Sachs, and other financial experts estimate that leading U.S. banks already have $2 trillion in bad debt from the subprime mortgage collapse. As the recession spreads through the economy like a malignancy, bank assets are losing value, and other loans are going sour, including commercial real estate loans, credit card debt, and millions of additional mortgages. All told, the financial system is facing possible total losses of $7 trillion. As free-market economists, we normally take a dim view of government intervention. But with the banks “effectively insolvent,” we’ve concluded that the only viable solution is nationalization.

Many banking experts are coming to the same conclusion, said Steve Lohr in The New York Times. The nation’s 50 largest banks “are dead men walking,” with potential losses far larger than their assets.  “When I talk to experts,” said Simon Johnson, a banking analyst at the Sloan School of Business at M.I.T., “after about two minutes they say, ‘We should just nationalize.’ That tells me that the consensus is moving in that direction, and we are all afraid to say it.” Nationalization may be a drastic step, said Martin Wolf in the Financial Times, but Geithner and President Obama are making a terrible mistake in throwing more money at the crisis and “hoping for the best.” It’s far more sensible for the government to take a majority stake in the banks worth saving. It could then sell off the bad debt and restructure the banks to the point at which private investors would feel confident enough to start putting capital back in. As the banks regained healthy balance sheets, Washington would sell down its stake. Some critics, including Geithner, insist that the government can’t manage assets well. But Sweden used nationalization to save its banking system in 1992.

Obama, unfortunately, is following Japan’s example, said Rich Lowry in National Review. During their own economic crisis in the 1990s, the Japanese government infused massive amounts of money into “zombie banks,” which were already basically kaput, to keep them afloat. All it got in return was “a ‘lost decade’ of economic stagnation.” That’s what could await us if Obama doesn’t “take the painful, risky step of letting some of the big, irreparably wounded financial players go down.”

Do you really understand what nationalization would mean? said Jim Cramer in New York. Under nationalization, every bank would write down its bad loans, and the government would “create a so-called bad bank to buy up those loans on the cheap.” That would cost taxpayers “5, 6, maybe 7 trillion dollars.” Our debt-ridden nation can’t afford to swallow another $7 trillion. Geithner’s plan is far preferable. It “allows the worst banks to go under while distributing the cost of saving the rest among taxpayers and private investors.” True, Geithner hasn’t offered many specifics. But give him a chance to “flesh out the details in the next few weeks and marshal the forces to get it through Congress.” If he fails, then, okay—we’ll put the banks in the capable hands of “the same people who manage Amtrak and the Postal Service.”

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