Nationalization Review

Given the Obama administration’s rapid takeovers of General Motors and Chrysler, it shouldn’t come as much of a surprise to conservatives that, in the name of "financial reform," President Obama is arguing that government should get vast new powers to seize private firms. What may surprise members of the center-Right coalition, however, is that the venerable conservative publication National Review is backing Obama’s bid to have the government do so.

he 85-page white paper the administration unveiled last week proposing a grab-bag of new financial regulations contains a prominent section on what it calls a "resolution regime" for "nonbank financial firms." In this "regime," the government would have, in the words of the Obama paper, "broad powers to take action with respect to the financial firm," including "the authority to take control of the operations of the firm or to sell or transfer all or any part of the assets of the firm."

One would think these would be fighting words for a conservative journal that for almost 55 years has vigorously opposed nationalization of industries in countries such as Cuba and Venezuela and has championed privatization efforts in Great Britain and attempts in the U.S. But an unsigned editorial posted last week on the magazine’s website actually says of the Obama plan, "The administration’s approach gets at least one big thing right." The editorial tries to make the case that "a resolution authority giving the federal government the power to seize financial holding companies … is actually not as scary as it sounds."

Obama and NR use roughly the same reasoning to justify these new powers. Without the government having this authority, they argue, the only choices are bankruptcies disruptive to the financial system or costly taxpayer bailouts of failing firms. In his June 17 speech announcing the proposals, Obama said, "We should not be forced to choose between allowing a company to fall into a rapid and chaotic dissolution, or to support the company with taxpayer money. That’s an unacceptable choice."

Similarly, the NR editorial, also issued on the 17th, states, "The bailouts have set the precedent that once a firm grows ‘too big to fail,’ its secured creditors will be protected, regarless of cost to taxpayer in order to prevent systemic spillover effects." The ability for the government to seize firms it deems as failing, NR opines, "would remove a layer of moral hazard by making failure a possibility, even for the largest firms."

In part, what the NR editors might be expressing is a form of "buyers remorse" on the original Bush-Paulson financial bailout they forcefully supported last fall. And not only did they strongly back that bailout, they berated GOP members of Congress who dared oppose it. In a September 29 Corner entry entitled "I’m Stunned" posted immediately after GOP conservatives and populist Democrats combined to vote down the bailout in the House (before a second package was approved there four days later), NR editor Rich Lowry exclaimed, "House Republicans will get blamed, and the likes of Mike Pence [R-Ind.] indeed played an extremely irresponsible role."

Now, National Review tells us that Obama’s resolution authority, "done right, would at least put us back on the road to a rule-based system." Its editorialists lecture sanctimoniously that "in post-bailout America, we have bad and less-bad options to choose from and we’ve seen the alternative: a series of ad hoc and largely lawless bailouts jerry-rigged by the Treasury and the Fed."

But there is every reason to believe that nationalization, or resolution, or whatever NR and the Obama administration wish to call this new authority, would be just as "ad hoc" and "lawless" as the previous bailouts and nationalizations.

Both NR and Obama justify the ability to seize firms based on the fact that the government already has similar powers regarding commercial banks. A government takeover "is essentially what the Federal Deposit Insurance Corporation does when it determines that a depository bank is on the brink of failing," NR intones in its editorial. Similarly, Obama argued in his speech: "If a bank fails, we have a process through the FDIC that protects depositors and maintains confidence in the banking system. … And it works. Yet we don’t have any effective system in place to contain the failure of an AIG [American International Group]."

It should be noted that contrary to Obama and NR’s assertions, the FDIC process of seizing banks is far from perfect. FDIC Chairwoman Sheila Bair, whom Obama held over because of the liberal policies she pursued in the latter half of the Bush administration (such as strong backing of the Community Reinvestment Act, as Matt Vadum reported in TAS yesterday), disregarded taxpayer interests upon seizing the large thrift Indymac and other banks and created a "model" mortgage modifcation program for thousands of borrowers that wrote off principlal on the loans and reduced interest payments to well below market rates. Initial results show a redefault rate in programs like these of more than 50 percent, but Bair and Obama show no signs of stopping this flawed experiment with taxpayer dollars.

But at the very least, the government’s ability to seize a bank is a condition of its service of providing deposit insurance. Bank owners and investors can forsee this possibility when the firm signs up to receive this insurance. There is no such nexus with nonbank buisnesses. And though Obama uses the example of AIG, his white paper puts no limits on the type of firm the government could seize. On page 19, the paper defines a "Tier I financial holding company" that woud be subject to seizure as "any firm whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed."

What type of business could that be under such an expansive definition? Well, it didn’t take long before the bailout intended for commercial and investment banks was applied to auto companies. And federal statutes governing banks, including the Patriot Act’s money laundering provisions, have already adopted a broad definition of "financial instiution" to include auto dealers, jewelry stores and travel agencies. It doesn’t take much imagination to see that a firm that the government deemed as a threat to "financial stability" could conceivably be just about any firm the government wanted to nationalize.

It’s also too bad that, in putting together the editorial, National Review didn’t avail itself of mainstrea conservative experts who argue that both that the financial fallout of the bankruptcy of Lehman Brothers was overblown, and that the financial system was put more in danger by the government’s bailout and nationalization to "save" AIG a couple days later that September.

In a Wall Street Journal op-ed last week, Peter Wallison of the American Enterprise Institute, who was general counsel to the Reagan administration Treasury Department, wrote: "The turmoil following Lehman’s failure occurred because market participants expected, after the rescue of Bear Stearns, that any larger firm would also be rescued. … Lehman’s failure itself did not cause any substantial losses, and within two weeks of its bankruptcy filing Lehman’s trustee sold its brokerage, investment banking, and investment management businesses to four different buyers."

Similarly, Stanford economist and Hoover Institution fellow John Taylor noted in another WSJ op-ed (and in his excellent new book on the crisis, Getting Off Track) that in the week after Lehman’s Sept. 15 bankruptcy announcement, "interest rate spreads increased slightly on Monday, Sept. 15, [but] stayed in the range observed during the previous year, and remained in that range through the rest of the week." It was only in the next week, according to Taylor, after Paulson and Fed Chief Ben Bernanke put together the bailout package and screamed economic Armageddon in testimony before Congress, "that one really begins to see the crisis deepening and interest rate spreads widening."

And Cato Institute economist Alan Reynolds points out the government’s taking of 80 percent of AIG stock — while infusing money in the firm mostly to  bail out its counterparties such as investment bank Goldman Sachs — caused its own systemic risk when ordinary shareholders feared that the government would nationalize other financial firms. "Financial stock price fell dramatically as soon as it became known that the loan to AIG … would be tied to expropriation of 80 percent of equity," Reynolds wrote. And in which publication did he write this? None other than the print version of National Review. Maybe the editors should have done a little more perusing of their back issues before they wrote their current editorial cheering government takevoers.

If there need to be any legislative changes to take account of systemic risk of failing firms, these should be incorporated by Congress through changes in the bankruptcy code that is applied by the judicial branch, as the Constitution provides for in giving Congress the power to write "uniform laws on the subject of bankruptcy." The Constitution never intended for the bankruptcy of individual firms to be an executive branch function, and the poltical favoritism in the Obama’s administration’s reorganizations of GM and Chrysler shows why. The judiciary isn’t perfect, but it it is much less likely to practice politicial favoritism in bankruptcies in the way that the executive branch is prone to. Some practical suggestions for bankruptcy code revisions for failing finance firms have been put forth by Richard Breeden, former chairman of the Securities and Exchange Commission, and Congress would do well to review his proposals.

In the meantime, conservatives’ only choice in responding to Obama’s "resolution regime" is to follow National Review’s onetime motto of "standing athwart" and "yelling stop." This is true even if the editors are now on board the Obama Nationalization Express.