Unintended Consequences of Nationalizing Banks

This is not a post for or against the actions of the Treasury. This is a quick look at what may be on the horizon–so that we can all keep our collective eyes open. I invite you to add your own observations and questions in the comments. I’d like to start you off with a couple.

Now that the US government has decided to force nine of the biggest financial institutions to take funds, what does that really mean?

  • What impact will there be on the internal risk allocation and compensation programs at these institutions?
  • In reference to JP Morgan, Goldman Sachs, and the rest, if the US government is going to limit risk in the short-term as a backstop to the taxpayer’s investment–what risks to they choose to limit and why?
  • Will some of these firms exit proprietary trading as a whole?
  • How will limiting risk affect shareholder expectation of returns?
  • Also, if you limit compensation, I don’t think it will be just CEOs singing the Paulson Prison Blues. What will attract the entry-level talent that looks to high performance bonuses at the upper levels as a goal?

This also means that the game for Wall Street is about to shift to new players. Make no mistake, a “Neo” Wall Street will arise from this action. The Citadels, SACs and others will fill the risk vacuum left unoccupied by the “old” investment banks. Also, key star players and their groups will migrate or go independent to escape financial and operational collars. And given that a lot of their options/equity compensation is underwater, the long-term incentives may be lacking to keep them in their current seats. The game may be changing, but this is not the end to global finance and capitalism.

My friend Roger Ehrenberg wrote down some of his thoughts on this issue, as well. Check out his two most recent posts:

Bailouts, Nationalism and Diplomacy

A Few Quick Thoughts on the Fed Plan

  • Roger

    I am most struck by two nascent, but dramatic, psycho-political shifts within Americana impelled by ongoing market crashes: diminishing isolationism and dwindling reliance on Big vs. Small Government policies to distinguish political Conservatives and Liberals. These emerging trends offer remarkable opportunities for engagement with global challenges and easing domestic political gridlocks.

  • It’s funny but most Wall Streeters enjoy political gridlock in Washington – it ensures the fact that no harm gets done. In the end if this crisis spurs people to get involved and take political action that will ultimately be a good. Concerned outrage citizens can be beneficial to policy creation. When phone lines in the house & senate ring, overwhelmingly, they have an impact .

  • They may be unintended consequences, but some of those consequences may be good.

    No doubt the very same thoughts were floated in the 1930’s after the rules changed for banking and security markets. When I was young, banking was a boring business and only second rate people went into the industry. That all changed by the 1980’s as transaction costs were reduced and the relaxation of rules allowed banks to play with new financial instrument, especially unregulated ones.
    We’ve had junk bond financing of M&A, which was like introducing the cannon in the middle ages, and balloon mortgages that pumped real estate like a Ponzi scheme. Unregulated CDS’s required the bailout of Bear Stearns and AIG simply because of the problem of unwinding these positions and their attendant counter party risk.

    The banking industry has grown faster and captured more of the total profits in the economy over the last few decades. Given the role of banking in the economy, I think it is arguable that something was going wrong with the system. I think that it can be argued that that was an unintended consequence of deregulation and that maybe reregulation, maybe even partial nationalization is worth doing.

    Smart people will go where the opportunities are. There really is a big beautiful economy to play in outside of the financial world.

  • Your question, ‘What will attract the entry-level talent that looks to high performance bonuses at the upper levels as a goal?’ seems to imply that entry-level workers expect to make high-performance bonuses themselves in a short period of time. I expect that once a company is able to clear it’s obligations to the government, then they can resume with the higher salaries and bonuses. If a person stays with a company through tough times, then maybe they can expect to be rewarded when the times are better.

  • As you may have heard, we in Iceland we’ve been hit pretty hard by the current financial storm.

    From witnessing that whole incident on the field. It seems quite obvious to me that the “new capitalism” will be built on a totally new level of transparency and information filings.

    A couple of my thoughts can be found here: http://hjalli.com/2008/10/06/the-future-of-finance-total-transparency/

  • Jo

    You make bankers sound like a rather nasty mutating virus!

    The Companies Act or the equivalent needs to be reformed.

    We have heard nothing in all this time of the responsibilities of the Directors/Boards.

    South Sea Bubble all over again. This is a governance issue on the surface and a political one underneath (who gets what).

    Yes there are unintended consequences to everything but think on this. In other countries, to own/possess/carry a weapon (even a spray deodorant) is a very serious offense. In the US .. . well each to his own My point is that we will have the regulation we deem necessary. It is what we deem necessary that is the point. Politics again.

  • Michael R. Bernstein

    “What will attract the entry-level talent that looks to high performance bonuses at the upper levels as a goal?”

    Gee, I dunno. Maybe these companies will be better-run if they rely more on intrinsic motivation, instead of extrinsic?

  • Greg Jung

    Radically large actions have already been taken to greatly benefit the banks, which have gone bust in their greed.
    A large part of the population has never been afforded the right to go into great debt, and therefore does not now benefit from the bailout largess; yet they have been profit centers for banks via the modest consumer debt serviced at unforgiving rates.
    Relief of consumer debt should be a big part of stimulus, and relatively costless (even profitable) in the wake of the banking bailouts.

    A national bank should be set up,
    1. seizing AIG, fannie Mae, etc.anything else in debt that much to Uncle Sam.
    2. Proceed to bank with the public, including unsecured debt.
    3. Interest on these should be systematically reduced as payment history is successful.
    (these are just a few quick points)
    If this model is massively implemented, other banks would be forced to match the terms. Instead of regulations, competition (albeit unfair) is used to delineate proper banking practices.

    We have already bit the bullet, now it is time to proceed with the surgery.