Joseph E. Stiglitz: A Bank Bailout That Works

[RedEarth]

The news that even Alan Greenspan and Senator Chris Dodd suggest that bank nationalization may be necessary shows how desperate the situation has become. It has been obvious for some time that a government takeover of our banking system--perhaps along the lines of what Norway and Sweden did in the '90s--is the only solution. It should be done, and done quickly, before even more bailout money is wasted.

The problem with America's banks is not just one of liquidity. Years of reckless behavior, including bad lending and gambling with derivatives, have left them, in effect, bankrupt. If our government were playing by the rules--which require shutting down banks with inadequate capital--many, if not most, banks would go out of business. But because faulty accounting practices don't force banks to mark down all their assets to current market prices, they may nominally meet capital requirements--at least for a while.

No one knows for sure how big the hole is; some estimates put the number at $2 trillion or $3 trillion, or more. So the question is, Who is going to bear the losses? Wall Street would like nothing better than a steady drip of taxpayer money. But the experience in other countries suggests that when financial markets run the show, the costs can be enormous. Countries like Argentina, Chile and Indonesia spent 40 percent or more of their GDP to bail out their banks. For the United States, the worry is that the $700 billion appropriated for the bank bailout may turn out to be just a small down payment.

The cost to the government is especially important, given the legacy of debt from the Bush administration, which saw the national debt soar from $5.7 trillion to more than $10 trillion. Unless care is taken, government spending on the bailout will crowd out other vital government programs, from Social Security to future investments in technology.

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Gradually America is realizing that we must do something--now. We already have a framework for dealing with banks whose capital is inadequate. We should use it, and quickly, with perhaps some modifications to take care of the unusual nature of today's problems. There are several ways we can proceed. One innovative proposal (variants of which have been floated by Willem Buiter at the London School of Economics and by George Soros) entails the creation of a Good Bank. Rather than dump the bad assets on the government, we would strip out the good assets--those that can be easily priced. If the value of claims by depositors and other claims that we decide need to be protected is less than the value of the assets, then the government would write a check to the Old Bank (we could call it the Bad Bank). If the reverse is true, then the government would have a senior claim on the Old Bank. In normal times, it would be easy to recapitalize the Good Bank privately. These are not normal times, so the government might have to run the bank for a while.

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http://www.thenation.com/doc/20090323/stiglitz?rel=hp_picks