Tuesday, November 25, 2008

What Would Nationalization of the Financial Sector Look Like?

Now that disgust with the financial sector and the government bailout is reaching a fever pitch, it's a good time to look at how nationalization of this wounded shark might proceed. Discounting those who foolishly defend the looting of public funds as nationalization, there are more and more calling for public ownership of financial institutions. Unfortunately, most calls for nationalization are short on specifics and potentially more harmful than helpful.

Below are some notes - admittedly tentative and sketchy - that may stimulate the discussion further.

1. What do financials "produce"? Essentially banks, insurance companies, and other financial institutions produce paper and plastic. More specifically, they deal in debt and other future obligations; they serve as an intermediary between people or institutions and money tendered and money borrowed or awarded.They collect assets from depositors, the insured, and investors and loan money or award money to willing borrowers or those meeting certain contracted conditions. What separates them from publicly-owned or cooperative financial institutions is profit. What they have in common with other privately-owned enterprises is, again, profit. Their primary mission is to make money and not serve any greater or collective cause. Their radical self-interest precludes any collective solution to the current financial disaster through individual bailouts precisely because their individual behavior is driven only by profit maximization. They have no social consciousness. Bailouts, like the current mega-gift to CitiBank, cannot work unless the profit motive is contained or by sheer dumb luck. Giving public funds to them is like giving drugs to a junkie.

2. If bailouts cannot work, what will? There is an essential need for the financial functions that are currently served by private institutions; without these services, there would be no economic activity, no hope for a better future. But for the vast, vast majority of people, these needs are fairly simple and easily administered: the accounting and distribution of compensation; insurance against life's unforeseen eventualities; loans for home purchase, education, consumer goods; guarantees of health care and retirement benefits; etc. Private institutions perform these functions poorly and at a high cost, duplicating services, incurring unnecessary expenses for marketing and promotion, thwarting economies of scale and, of course, expanding profits.

In addition, private financials are genetically determined to go beyond the essential functions of banking and insurance into areas of speculation. The profit imperative encourages speculation. If they engaged in reckless behavior with their own money, no one would care. But they are in the unique position of gambling with other people's money: deposits, retirement funds, insurance funds, savings, etc. Moreover, they are driven to take more extreme and socially irresponsible choices in pursuit of profit: securitization, derivatives, CDO's, and a host of other instruments that are impossible to explain or understand. The results are what the pundits call "toxic assets". They are indeed toxic because they engage and affect the fate of millions of people, but they are hardly assets. The real, original value of these instruments has been squeezed out through fees and charges, leaving nothing else but nearly worthless paper.

3. So what should be done? Three options are available. Firstly, we could shore up, at public expense, the speculative functions of the financial industry. This is the policy of the Bush administration and most of the Democratic opposition. Obama has not rejected this approach. It cannot and will not work.

Secondly, we could broadly nationalize the financial sector, paying current market value for their assets and taking on the essential financial services as well as the "toxicity".

Or, thirdly, we could simply create the means - easily and quickly - to provide the essential financial serves required by most of us. In other words, we could devise the necessary "products" through government agencies to provide - without profit, marketing costs,high management salaries, etc. - housing, automobile, health, home owners insurance; student loans; mortgages; consumer loans; etc. This move would fulfill the unrealized promise of Fannie Mae, the Federal National Mortgage Association, established in 1938. While Fannie Mae only addressed one aspect of the financial crisis of the Great Depression, it pioneered the creation of government institutions that supplied essential financial services formerly provided by the private sector. Over time, virtually all the existing financial liabilities incurred in the private sector could be absorbed by refinancing into the public sector. Such a move would be both rational, efficient and cost saving. Imagine if the estimated $7.7 trillion (the total value of ALL mortgages in the US is estimated to be $10.6 trillion!) already gifted to the financials were put to this use, a figure that is both wasted assets and equally a liability on the citizens of the US who must pay for it.

4. What would happen to private financial services: banks, insurance companies, etc.? They would remain whole based upon fair market compensation for any of their assets surrendered to the public sector, but they would be left to their own devices to dispose of the "toxic" assets that they have created. This harsh measure would eliminate the moral hazard of unfettered financial speculation, discipline their practices, and lower their profit expectations to levels commensurate with their actual productive value. I predict that they would shrink to service financial niches much as private doctors do in some countries with national health care.

5. Would there be other advantages to this nationalization other than stepping over the toxicity of greed fostered by the private sector? Sure. The current banking system is antiquated, changing slowly to adjust to new technologies. To a great extent finance is moving quickly to electronic transactions, but less so below the level of high finance. On the consumer level, the industry is still dominated by a "brick and mortar" approach , but with declining service stretching customer tolerance. Automated telephone systems, hidden penalties, long service queues, massive paper work, deceptive contracts, etc. are common complaints about the financial system. In addition, the security concerns associated with financial transactions engage draconian tactics, zero tolerance and extreme penalties, all, in the final analysis, enforced by the government.

Furthermore, the era of printed money and coinage is coming to a close only hindered by the untold cash transactions that the banking industry conducts with criminals and tax-evaders. Super-profits give the private bankers no incentive to report or hinder these transactions in the illegal economy.

A publicly-owned and democratically run financial organization free of the profit motive would eliminate the wasteful duplication of brick and mortar facilities, moving most financial transactions to the internet or other electronic media. Where two or three drive-thru banks are in one city block or in one mall, facilities for those unable to access or use these technologies would be strategically placed for convenience rather than where the money flows most freely. Uniform credit and debit cards, procedures, terms, and universal acceptance would replace the chaos and uncertainty found today. Consumers would democratically determine service levels and service mechanisms, balancing cost-effectiveness with ease of usage. Enforcement of obligations would, as with a humane health-care system, stress prevention over punitive remedies. Moreover, enforcement of obligations would be elastic to adjust for circumstances and external conditions, unlike with the shameless foreclosures and repossessions exploding in the current crisis. Needless to say, government monitoring of criminal finances would be vastly improved: drug dealers don't use credit or debit cards.

6. But what about enterprise financing? Assuming - contrary to my vision - private enterprises still exist, they can be financed directly from the government. Quietly - a few months ago - the Federal Reserve opened loans directly to financial corporations without the intermediary of banks. There is nothing different - except for cost-savings and efficiencies - in making this a general practice of a publicly-owned, democratically run central bank. Loan decisions would include, contrary to today, matters other than profits: environmental impact, social consequences, long term effects, etc. Certainly if private investment banks can serve this function better and more efficiently, but under government scrutiny, they are welcome to try.

7. Does this nationalized financial sector include insurance? Nothing in the private financial sector is as utterly parasitic as the insurance industry. A monkey could take the government funded and researched demographic data and contrive actuarial tables to balance set-asides with projected expenses. The trick, for the private sector, is to shave enough away from realized expenses to accrue a profit from accumulated charges. They have been very successful at the expense of equitable and efficient use of the resources they accumulate. They do this in many ways, including "over-insuring", denying insurance to the unlucky, denying benefits, offering misleading terms and coverage, inflating liabilities, and buying out the regulators. And in recent years, they have taken their reserves - set aside to cover beneficiaries - and gambled them in the insane speculative carnival that is now bringing down the entire financial sector. The insurance industry is the ultimate huckster.

It would take less than a week to establish a government agency to perform the functions of the insurance industry, an agency that would be more efficient, responsive, humane, and cost-effective than what we have now. I might add that without private insurance, the single-payer health care solution would not only be more likely, but essential.

8. In its simplicity, cost-effectiveness, and social responsibility, this nationalization option would best serve the needs of 90% of the people in the US. Perhaps, the other 10% would be less pleased. They could explore other options. But the poison of unbridled speculation would be expunged from the productive economy.

I offer this sketch of financial nationalization, not as a blue print, but as viable and attractive alternative. Such an option would not come about from the will of a treasury secretary or "progressive" president, but from an intense, determined class struggle. The forces arrayed against such a plan are formidable, but there is no better time to press for it.

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