Protecting the economy from the banks*

I was wondering a few days ago in my discussion of Obama's inauguration speech what could possibly become of the banks in Obama's brave new world. Tight regulation, capitalization and perhaps insurance for the banking conglomerates that will survive the crisis was what I had in mind. Yet I read today in the New York Times that the new administration is seriously considering nationalizing banks. I am astonished. Besides the fact that this shatters an ideological consensus of more than 25 years, it also spells out extreme government intervention in a sector that was really the pinnacle of free market capitalism. And it is happening really really fast. But again we are living in unusual times. In a sense, it has already happened in Britain with the de facto nationalization of RBS and Lloyd's. And it has happened before in the US in 1983, when Reagan and Bush Sr., of all people, nationalized the Continental Illinois National Bank and Trust company. It is also the logical conclusion of the steep decline in trust that has plagued the banking sector and that has naturally put in the brightest spot the ultimate creditor, the national government. Nationalization is, however, extremely costly and means that the taxpayers will take up all the costs and the governments all the risks. It also sets in motion the wheel of interaction between politics and economics that spells out inefficiency and corruption. Of course, at this point none of these tradeoffs seems worse than sticking to the financial panic of the last 3 months. On the other hand, I am wondering if cartelization might not be a better option.

*The quote is taken from a recent report by Mervyn King, the governor of the Bank of England.