Greenspan Finally Gets It Right on Banks

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Investors have been disappointed by the Obama administration's lack of specifics regarding its "bad bank" plan to remove soured assets from bank balance sheets. This week, Federal Reserve ex-Chairman Alan Greenspan added his voice to the debate, when he recommended that the government consider wholesale bank nationalization, Greespan calls it "the least bad solution." And he's right.

"When the facts change, I change my mind -- what do you do, sir?"
Like Greenspan, I'm a free marketeer, yet I accept the idea of nationalization under extraordinary circumstances. When the facts change, you're better off imitating Keynes and changing your mind. For one thing, nationalization is already upon us. The government has seized control of mortgage giants Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) , as well as troubled insurer AIG (NYSE: AIG  ) . Furthermore, if we exclude a muscular response from the government on troubled banks, the outlook for an economic recovery is pretty bleak.

The Japanese gave us a blueprint of what not to do in the 1990s: dither about, and ignore the reality that important parts of the banking sector are insolvent. That approach gave Japan a "lost decade" of economic stagnation. We are now faced with the same situation: As Martin Wolf pointed out in the Financial Times, the fundamental problem of the U.S. banking sector is not one of liquidity, it is one of solvency -- i.e. where the liabilities of certain banks exceed their assets.

Dealing with the three categories of banks
In that respect, I'd rather salute Greenspan's pragmatism than criticize him: It would be foolish to maintain a rigid free-market stance when you are faced with distressed institutions that are "too big to fail." (To be fair, free marketeers would resist letting any institution become too big to fail from the outset.) Institutions in that category -- Citigroup (NYSE: C  ) certainly comes to mind -- should be nationalized and recapitalized before being broken up, with the separate units eventually privatized.

The institutions that don't pose a systemic risk and are insolvent must be allowed to fail. Finally, those that are reasonably fit, such as JPMorgan Chase (NYSE: JPM  ) , Wells Fargo (NYSE: WFC  ) , and US Bancorp (NYSE: USB  ) , should be left to go about their business without undue interference from the government.

Let's not turn Japanese
There is no room for "zombie banks" if we wish to pull the ailing U.S. economy out of its morass. Failing that, we need only look at Japan's experience to get a glimpse of the disastrous fate that awaits us; yesterday, the broad-based Topix stock index in Japan came within 5 points of closing at a 25-year low.

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Fool contributor Alex Dumortier, CFA, has a beneficial interest in Wells Fargo, but not in any of the other companies mentioned in this article. US Bancorp and JPMorgan Chase are Motley Fool Income Investor selections. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (11) | Recommend This Article (31)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 18, 2009, at 3:31 PM, mlaursen wrote:

    Or the failing banks could go through good old traditional bankruptcy procedures, ultimately being bought out by better-managed banks. What would be wrong with that option?

  • Report this Comment On February 18, 2009, at 4:07 PM, jasonjim wrote:

    To nationalize a bank like BAC, which I see you don't mention in your negative diatribe, would be a disaster for America. Who would run it, Alan Greenspan lol, the same guy that helped get us in this mess in the first place? The state cannot even run the country properly let alone a bank the size of Bank of America. So would Lewis continue to run it if it was nationalized; if so why nationalize in the first place? Nationalization sounds like an easy way out of a difficult situation but the same problems like toxic assets will continue to exist whether the banks are nationalized or not nationalized. So address the damn problem, which is establish a damn market for the toxic assets on the books of the banks, and back the assets with government guarantees so that the buyers know they are not buying a pig in a poke. As a Motley Fool subscriber (not for very much longer) I am very disappointed that the Fool is advocating strongly for nationalization of the banks. I have come to the conclusion that the Fool should be renamed the Motley Idiot instead.

  • Report this Comment On February 18, 2009, at 4:46 PM, whereaminow wrote:

    Alan Greenspan wrote these words in a 1967 essay Gold And Economic Freedom:

    "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves."

    Then he went on to work for the Federal Reserve, where he systematically confiscated wealth through inflation. Greenspan was no free marketeer once he started working for The Fed (a cartel of private bankers).

    Do not mistakenly perpetuate the myth that Greenspan believed in free markets. The Federal Reserve is not a free market system. Greenspan, while Chairman, believed in bank de-regulation. However, without requiring 100% reserves, the only way to keep a bank honest is to let it go bankrupt.... or nationalize it. It's the choice between responsibility with consequences, or living like animals - which is where we are headed.

    "Government is the great fiction through which everyone endeavors to live at the expense of everyone else." - Frederick Bastiat

  • Report this Comment On February 18, 2009, at 11:35 PM, jerryguru69 wrote:

    Well, I mean, the question of nationalizing banks is kinda moot, eh? FRE, FNM, AIG already are nationalized. The question before the house is whether C and BAC should be added to the list?

  • Report this Comment On February 19, 2009, at 8:50 AM, rm96696 wrote:

    I have noticed that the "swedish model" (nationalizing banks and the reselling them) seems to be in vogue right now since the swedish economy seems (seemed?) to have recovered well after the depression and banking collapse of the early 90's. However Finland, which followed a different route (it took control of some savings banks, but mainly lent money to the banks, merged weaker banks with stronger ones and sold off the healthier bits of the savings banks) also recovered strongly after the depression and the banking collapse.

    So maybe it wasn't the nationalization of the banks, or how the governments reacted in general, that did the trick. Maybe other factors (leaving the european exchange rate mechanism with consequent 500% overnight rates, recovery of eastern europe, buoyant export markets, devaluation...) were more important.

    Are we sure that zombie banks were responsible for japan's "lost decade"? How about lack of innovation, massive appreciation of the yen and the asian crisis?

  • Report this Comment On February 19, 2009, at 9:13 AM, Crippy wrote:

    why is Citibank too big to fail? What happens if it goes broke?

    No, there is no room for Keynesian economics anywhere. When a a theory or theories do not work in practice the theories are worthless as well.

    It is ideas like this that have pushed us to where we are today. The Looters have taken over.

    Time to cancel my subscription.

  • Report this Comment On February 19, 2009, at 11:39 AM, oceantraveller wrote:

    Japan zombie banks-they do not immigrants and poor birth rates,during Kobe earthquake a lot moneys were found stashed in the houses of old people.

    Still long lines of immigrants in US embassies.

    Nationalisation - by the time they completed the regulations,the economy will have gained tractions.

    Imagine the resources and time that will be spent for the Nationalisation of the banks.

  • Report this Comment On February 25, 2009, at 4:15 PM, McCrikey wrote:

    When the facts change, I don't change my principles.

    When we abandon our economic freedom we also abandon our political freedom.

    Today we seize banks. Tomorrow we round up dissidents in the middle of the night.

    See you at the re-education camp, pragmatic national socialists. I'll be the one saying "Told you so."

  • Report this Comment On February 25, 2009, at 10:29 PM, brwn8484 wrote:

    Are you serious? The last time we went through this bank reorganization/govt takeover we had a run on the money markets that would make the depression run on banks look tame. How are you going to protect all the shareholders and third parties.

    I will bet that the same Idiots that caused the last money market run are the ones at the center of this nationalization stupidity. If you all want to lose your hard earned retirement and investment plans go ahead.

    This is definitely not in the interest of the middle class. But noone has paid any attention to us for the last 50 years anyway.... so why would it change now. This is definitely a CY_ and protect my rich political and corporate friends idea. The media is so gullible they have become the biggest cheerleaders to all this criminal and insane behavior. I thought we were going to see some real change. At least thats the standard lie used to gain the whitehouse seat. Oh well.... nothings changes just the nameplate.

    Hang on boys.... just when you thought it was safe... I bet we will see a lot more down before we see any up. Given he idiocy in our leadership, I expect we may be in for a doozy of a depression.

  • Report this Comment On March 04, 2009, at 1:29 AM, Nothing4Names wrote:

    I admit that I'm a little undereducated when it comes to this stuff. However, it seems to me that what could be used in this situation stops short of nationalization in terms of its' long-term implications (government owning or owning shares in the banks) is a 1933-style "bank holiday" with the feds investigating the books and doing what needs to be done with them.

  • Report this Comment On March 04, 2009, at 1:30 AM, Nothing4Names wrote:

    "..what needs to be done with the banks on an individual basis."

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