Is Bank Nationalization Really the Way To Go?

Matt Yglesias puts forward some of the current arguments for nationalizing insolvent banks; Paul Krugman and Felix Salmon are pushing a similar approach.  Maybe, but I'm not yet convinced.

It's easy enough to argue that any single bank yields a superior result when that bank is nationalized rather than bailed out, for reasons ably discussed for Matt.  The problem comes with the banks that sit on the margin, namely the banks that do not yet need either nationalization or a major bailout. 

Ideally we would like to see those banks recapitalized through private capital, with any or much public sector involvement.

Now what is the policy most likely to discourage such recapitalization?  Yup, bank nationalization.  Why put your private capital into a sector that has attracted the attention of government in this manner?

The risk is that nationalization becomes a contagious idea and spreads from one bank to the next, acting as a self-fulfilling prophecy.  Even mentioning "the N word" scares off private capital, so if the government is not going to nationalize, a precommittment to that effect would be useful.  Either that, or get it over with.

Subsidies and bailouts, of course, have their own problems, most of all that they cost money.  But it also costs money to recapitalize a nationalized banking system.  I've yet to see the evidence that the nationalization option would be cheaper.  And if nationalization increases the number of banks that require assistance, one way or the other, it could well prove more expensive in the longer run.