Who should run the banks?

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When I hear a comment like "we should nationalize the banks," I assume that the speaker is the sort who thinks that such a policy will take bank management out of the hands of greedy, mistake-prone people and put banks in the hands of wise, benevolent public servants.  

Instead, I think of a government takeover of banks as something that changes the rules and incentive structures under which bank managers operate. With rules and traditions in place, as in the FDIC process for dealing with failed banks, I believe that a government takeover of an insolvent institution can be handled fairly and reasonably efficiently, although never perfectly.

The ad hoc process, under TARP and the various weekend-at-Bernanke's sessions held last year, has some dangers.  In particular, the government seems inclined to follow a "hold and manage" strategy rather than a "carve up and sell quickly" strategy for dealing with troubled institutions.

For example, if you were following the FDIC process with Freddie and Fannie, you would be carving them up into bite-sized pieces and selling them off.  Instead, government is keeping them, and it is hoping to use them to reduced mortgage rates.

This is a horrible, horrible idea.  Mortgage rates are ridiculously low right now.  You can get a 30-year, fixed-rate mortgage for less than 5 percent.  I saw what happened to the S&L industry when they were caught holding 30-year mortgages with 6 percent interest rates in the 1970's.  If you make a 30-year fixed-rate loan at less than 5 percent today, then good luck to you.  

It is easy to imagine short-term interest rates over the next thirty years averaging 5 percent or more, in which case anyone who lends at less than 5 percent will lose money.  If rates average 10 percent, which easily could happen given the crazy trends in fiscal policy, you would lose a fortune lending money at 5 percent.  I don't think that the probability of the opposite happening--making a nice profit because short rates average 2.5 percent over the next thirty years--is anywhere near as high. 

I am fairly confident that the only people you can get to make thirty-year fixed-rate loans at current interest rates are the taxpayers.  They only do it because they (we) have no choice in the matter.  

We own our house free and clear.  But as a taxpayer, I am so unhappy about lending money to people for thirty years at less than 5 percent that I am tempted to go out and get one of those mortgages, just to hedge myself.  

If you think that the private financial sector did a lousy job with your money, you ain't seen nothin' yet.

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Arnold Kling

Arnold Kling earned his Ph.D in economics at MIT. He was an economist on the staff of the Federal Reserve Board. From 1986-1994 he worked at Freddie Mac. He started Homefair.com in 1994 and sold it in 1999. His fourth book, From Poverty to Prosperity, co-authored with Nick Schulz, is due out in April of 2009. He blogs regularly at Econlog.
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