Speaking to the FT ahead of a speech to the Economic Club of New York on Tuesday, Mr Greenspan said that “in some cases, the least bad solution is for the government to take temporary control” of troubled banks either through the Federal Deposit Insurance Corporation or some other mechanism.
The former Fed chairman said temporary government ownership would “allow the government to transfer toxic assets to a bad bank without the problem of how to price them.”
But he cautioned that holders of senior debt – bonds that would be paid off before other claims – might have to be protected even in the event of nationalisation.
“You would have to be very careful about imposing any loss on senior creditors of any bank taken under government control because it could impact the senior debt of all other banks,” he said. “This is a credit crisis and it is essential to preserve an anchor for the financing of the system. That anchor is the senior debt.”
Greenspan–and most of the advocates of nationalization–miss the point when he/they say that government seizure of the banks sidesteps the pricing problem. This is especially true in Greenspan’s case, when he states that it is necessary to protect the interests–and thus the value of–senior debt.
Yes, it is true that by seizing some banks, and stripping out their assets, you don’t have to price them. But, the value that the current claimants of the seized institutions receive in a nationalization implicitly prices the bad assets, along with all of their other assets and liabilities in the bargain. Greenspan wants to conserve some of the value of senior debt. Presumably this would entail wiping out junior debt, preferred equity, and common equity. That effectively puts a price on the value of the seized institutions. The individual assets and liabilities are not being priced, but by pricing the claims on the firm, you are assigning a value to all its assets and liabilities.
Indeed, the pricing issue is even more complex in a nationalization, because you are pricing all of a seized bank’s assets and liabilities, including, for instance, the franchise value arising from its deposit business and the information it possesses about borrowers. Once you pick the compensation (which could be zero) that current claimants receive, you have effectively priced everything. (A constitutional hurdle may require some compensation. The 5th Amendment requires compensation for all property seized for any public purpose.)
The pricing issue is thorny primarily because of its distributive consequences. Pricing individual assets or portfolios of assets in transactions between banks and the government determines an allocation of wealth, or more accurately, a probability distribution of wealth allocation, between the taxpayers and those with claims on the banks. (It also affects the allocation of wealth among the bank claimants.) But nationalization, nationalization light, guarantees, what have you, also imply a distribution of wealth between taxpayers and bank claimants.
One possible objection to arms length, voluntary transactions between the government and the current asset owners is that due to information asymmetries, the current asset owners will have an advantage in negotiations, and as a result the transactions prices will favor them. This would result in a wealth transfer from the taxpayers to the current asset owners.
Conversely, a related objection to nationalization–a transaction forced by the government on unwilling private claimants, at a price dictated by the government–is that the government would have an advantage that would permit it to extract wealth from the holders of bank debt and equity.
In other words, any policy choice has distributive implications. That is, assets and liabilities are valued, one way or the other. It cannot be avoided, finessed, sidestepped. Those who prefer one approach to another, are expressing a preference for one distribution of wealth between bank owners and taxpayers, and another.
Moreover, in a world with frictions and transactions costs, wealth distribution can have efficiency effects. Taxes are distorting, so policies that transfer wealth from taxpayers to bank owners tend to increase deadweight losses from taxes. However, in a world with informational frictions and transactions costs, undercapitalized banks offer inefficiently low levels of intermediation, creating other deadweight costs. Similarly, nationalization can lead to distortions due to the politicization of lending and investment decisions.
These are all thorny, difficult issues. There is no immediately “right” policy. However, it is better to approach the problem based on a recognition of the distributive and efficiency implications of alternative approaches, rather than to propose a policy based on facile, not to say puerile, analyses like Greenspan’s. His statement that nationalization avoids pricing problems is just plain wrong, and is arguably all the more dangerous because it offers the false promise of avoiding the issue of that has derailed all previous attempts to solve the crisis. Nationalization doesn’t avoid the pricing problem; it assigns prices by fiat.
Listening to Greenspan of late makes me wonder whether he’s lost it, or never had it in the first place. I’m leaning towards the latter interpretation.