The Nationalization of Banking in the United States

Since the depths of the financial crisis in the fall of 2008, the United States government has become intimately involved in the ownership and operations of the financial services industry in general, and the banking system in particular. The US Treasury has made equity investments in major banks, and has become the major supplier of capital and liquidity to these largest banks. Since everyone knows that a major debtor is really an equity investor, these moves have essentially amounted to the nationalization of banking in the US. Anyone who doubts that the US government believes that it owns the banks has not been listening to recent speeches by President Obama and the US Congress.

Nationalization of the US banking industry is bad for the economy for all the reasons that nationalized industries have been bad throughout history in any country you choose to examine. This is especially so in the US because the free flow of capital is so important to the growth and vibrancy of our economy. Federal government intervention in the United States financial services industry will degrade the ability of the economy to function and to recover quickly from the current recession.

The US government is not just another investor among equals, it is an investor with a gun. The federal government will dictate the strategies, culture and actions of banks disproportionately to its ownership stake. The CEOs and management of the US financial institutions no longer work for traditional profit-motivated investors; they are working for the State. They are no longer motivated by making profits for investors – and themselves. Their compensation will look increasingly like that of civil servants, in which there is no upside reward for innovation and risk-taking, and in which the primary goal is job preservation by avoiding risk and responsibility for decisions that might have negative outcomes.

Today’s major bank CEO now works for the Secretary of the Treasury, and in reality, works for the Chairman of the congressional Banking Committees. The first time anyone forgets that, he will be called into a Congressional hearing to remind him. Those hearings will be called when major losses occur, when major expenditures are made without political benefits, or when politically correct lending is not extended. The management of financial institutions will now be motivated to not have any losses, so risk taking of any type is out. These government-owned institutions will no longer participate in the type of aggressive risk-taking that has funded the largest and most dynamic economy in the world, and that has built the globe’s largest and most efficient capital market.

The management of these government-owned institutions will be motivated to make lending decisions based on political goals, rather than the merits of the loan itself. We will see much more lending to the relatives, friends and political donors of Congressmen, lending in certain Congressional districts, lending for questionable but politically correct projects, and so on. Bank lending will become the new source of “earmarks,” and the new source of money for the politically connected to loot. Any banker that forgets who is really in charge will find themselves called before a Congressional committee to be publically excoriated, humiliated, and professionally destroyed. Only a few examples will be required to teach this lesson to the rest. Making money is no longer the goal of banking – buying votes is the objective.

The tragedy for the American people and our economy is that massive intervention and Federal seizure of the financial sector was not necessary. The industry needed to go through the catharsis of bad decisions being rewarded by bank failures. Overly inflated financial assets needed to be revalued to sustainable levels – and still need to. All of this could have happened, albeit painfully, and the economy would have absorbed the pain, learned its lesson, readjusted to the new reality, and moved on to the overriding goal of growing by creating wealth. The actions of the US government are only serving to defer this necessary cleansing process, prolong the recession, and seriously degrade the capital markets.

The private equity market has grown tremendously over the last decade in response to increasing government intervention in and regulation of the public equity markets. Now private equity remains the great unregulated hope for capitalism in the United States to provide the investment capital and profit-maximizing guidance that will once again create growth in the American economy. That is, unless the major US banks can quickly pay off the government investments and get out from under the Congressional boot.