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A simplified explanation of America's banking crisis and how it might be fixed

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But let's consider a second way the government could address this whole mess.   The government could say to bankers, okay dude, let's get real.   Banker Bob is just going to have to recognize his loss on Caitlin's dollhouse.   He's going to have to honestly admit that yes, he's 50 dollars in the hole.   So, his capital is wiped out.   Plus, he owes his depositor, Alex, 40 bucks.  

However, in this second plan, the government comes in on the other side of Banker Bob's balance sheet and covers his losses -- it provides 40 dollars to pay back Alex, and it replaces the 10 dollars in capital that got wiped out and that Banker Bob thought he had lost.   Now, however, the problem is, if the government puts in that much capital, then the government now essentially owns the bank.  

Bob's response to this is:   I don't like this plan.   I lose my job.   I don't like this kind of government takeover of private industry.   It's nationalization.   I hate nationalization.   This seems like socialism to me.

But, at least this way, as taxpayers, we have an ownership stake in a bank, not just some crappy, overvalued dollhouse.   The government will clean the bank up, sell it to someone else down the road, and ultimately we'll get most of our money back.   And frankly, the taxpayers don't really mind that the bankers will lose their job and their money.   After all, they're the ones who got us into this mess.    And, besides, this is the traditional way that governments around the world usually fix banks that get into this kind of a mess.


For the last 20 years, Simon Johnson has worked on banking crises all over the world.   As already mentioned, he used to be the chief economist for the International Monetary Fund, an organization that has stepped in, over and over around the globe, to fix just the kind of crisis we're in now.   And the IMF with the United States pushed countries in similar situations to do what?   To nationalize their banks -- temporarily.   Examples:   Indonesia, 97, Korea, 97, 98, Russia, every couple of years, Argentina, in 2002.  

Simon Johnson continues:   "What would the U.S. tell the IMF to do if this were any country other than the U.S.?   Assume you covered up the name of the country, and just showed me the numbers, just show me the problems, talk to me a little about the politics in a generic way.   What would the U.S. tell the IMF to do?  I know what they would tell them and I know what the IMF would do:  Take over the banking system.   Clean it up and re-privatize the bank as soon as possible.

So why is the United States not taking its own advice?

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Simon Johnson:   That is a great question.   A huge question.   My take is that it's too political.   The politics are awkward.   Cleaning up a banking system, is technically not that difficult.   But, when you clean up a banking system, and you do it properly, some powerful people lose.   They lose their bonuses, they lose their banks, they lose their access.     So which politicians are going to be the ones who are going to help bring the hammer down on the bankers who contribute so much to their campaign funds?   Frankly, I don't think most members of Congress are ready to even have that conversation.

One of the reasons they might not be ready to have that conversation has to do with the practical challenges of taking over the banks.   Columbia Business School professor David Beim knows about this.   He has experience assisting the U.S. government in taking over American banks.   This was back during our last banking crisis, the Savings and Loan crisis in the late 1980s.   When that crisis hit, Beim started advising the FDIC on the problem, which was a big one.

David Beim:   Every large bank in Texas and Oklahoma failed in that era.   Every one of them.   It was the biggest banking crisis America had faced since the Great Depression and yet, compared to what we have now, it was nothing.

What I faced in the '80s was a regional crisis; so that, the FDIC was willing to shut every major bank in Texas and Oklahoma and cleanse them of their bad loans, re-launch them with new management, and new shareholders.   That was the best practice of the day, and they did it very well, and they got through the mess.   And they got through it elegantly.   But it's much harder to do that for the nation as a whole.   It's harder to say, all the big banks should now be closed.   Much harder.  In fact, you would not want to do such a thing all at once.   This crisis has advanced so fast and so globally that such a rash move would be quite dangerous.   It's not just the United States, you see;   banks are on the verge of crashing all over Europe.   In fact, the banks of Europe are actually in worse shape than the banks in the United States.   Even the banks that never touched a mortgage-backed security are in worse shape.   This is a global crisis.   It's absolutely everywhere.   And under those circumstances it's much much more risky to advocate closing down all the banks.

Exactly what is the difficulty?   Is it simply that you need somebody to sell the assets to, and if you're taking over the biggest banks in the country, there's nobody to sell the assets to?

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David Beim:   Yes.   You can easily sell one bank.   I'm sure you could put some buyers together -- there's private equity funds and others who I'm sure could be found for one bank.   But to buy the banking system of the globe is rather a tall order.

There's another practical challenge to taking over all of our insolvent banks.   The government might very well not have enough people to do it.   The one time the FDIC actually fully nationalized a U.S. bank -" which was Continental Illinois, in 1984 -- it took more than a hundred government regulators.   Citibank alone is 20 times bigger.   And the banking system is far more complicated now than it was then.   One expert told me we might be talking about thousands of people needed for each bank we take over.  

A second problem:   Nationalizations are kind of like potato chips.   It's hard to have just one.   You'd have to come out with a plan for all of them -- or all the big banks anyway -- and you'd have to do the whole thing in one day, at one time.   Because if you just start taking over one bank, people with money at other banks will start worrying that THEIR bank will be nationalized next, and that will cause investors to panic and they'll pull all their money out of that bank.

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Several years after receiving my M.A. in social science (interdisciplinary studies) I was an instructor at S.F. State University for a year, but then went back to designing automated machinery, and then tech writing, in Silicon Valley. I've (more...)

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