Taxation Without Representation

Being the congenital liberal I am, when people say "we shouldn't nationalize the banks" I go "why the heck not?"  William Isaac provides some good reasons not to nationalize in an interview with Planet Money.  To summarize his arguments:

• Banks need investment to function normally.
  
• Investment is predicated on the bank growing or at least continuing its business.
  
• Banks make money off financial risk.
  
• A bank that's been nationalized has by definition taken on too much risk.
  

And thus the conclusion is unfortunate: the process of nationalizing the bank to lower its risk profile to protect tax payers inherently goes against its normal functioning.

But I sure am wondering whether this is really as bad as the other option: shovel money into the banks hand over fist and hope that this somehow helps us.

If there's just one idea that I think summarizes the entire financial disaster we're in, it's asymmetric risk.    Any time we have a heads-I-win-tails-you-lose game in a financial market place, the resulting behavior from the people involved is 100% predictable, and we have to ask ourselves "why did we make the rules this way."

John Bogle talks a lot in his books about the critical role that owners play in making capitalism work.  The owners of a company have skin in the game - for them, they win when the company wins, but they lose when the company loses (by losing their investment completely).  Contrast with the managers of the company, who win (perhaps to a much smaller extent) when the company wins, but are not nearly as exposed to losses.  If Citi loses $8 billion dollars, Citi's CEO doesn't personally lose $8 billion.  (And stock options don't fix this - stock options are totally asymmetric!  One might argue that they just make the problem worse.)

Simply put, owners are the ones who have skin in the game - they put up money which can be lost completely, so they're the ones who are supposed to make sure that the managers who work for them are not being complete morons.  In Bogle's calculus, one of the biggest problems with America's financial system (his books were written before the crisis, but I think the systemic problems he describes are still fair game) is that today's owners are not keeping today's managers from looting the bank.

Managers have asymmetric a risk-reward situation, so we can't trust them to do the right thing. We need owners with skin in the game to make good decisions.

I can't think of a bigger heads-I-win-tails-you-lose situation than us (the tax payers) saying: "hey senior bank management, we know you need money, so we will give you lots and lots of money.  But don't worry, we won't fire you if you continue to screw up."

If there is one threat to our free markets bigger than having the government come in and derail economic activity via a series of arbitrary political decisions about capital deployment, it's having the government  come in and completely derail economic activity by providing free capital to the management of the largest, least-well-run institutions without imposing on management the discipline that owners must impose.