What Does It Mean to Nationalize Banks and Industries?

Architectural details on old bank building, Americus, Georgia, USA
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During times of financial crisis, the U.S. government sometimes provides relief designed to stimulate the economy and prevent economic disasters. The result is that the government plays a significant role in the fate of many businesses, and the topic of nationalizing banks may come up. 

Most bank customers and taxpayers are unaware of how that works, but the subject stirs lively debates. So, what does it mean to nationalize banks, and how would nationalization affect banks?

What Is Nationalization?

Nationalization occurs when a government takes over a private organization. Government bodies end up with ownership and control, and the previous owners (shareholders) lose their investment.

For example, banks in the United States are typically businesses—not government agencies. The owners might be stockholders, a family, a small group of people, or other investors.

Unilateral Action

In nationalization, ownership and control transfers to the government, usually as a unilateral decision. In other words, the private owners and managers don’t decide or agree to transfer ownership—the government makes that decision for them. Shareholders typically have little choice but to accept the change.

Stakeholder Losses

When nationalization occurs, the previous owners and managers often lose their ownership interest. However,  individuals in management positions may be fortunate enough to keep their jobs.

After nationalization, the previous owners no longer control an asset that has value: potentially generating income, or appreciating for sale at a profit. Instead, the state owns nationalized assets. As a result, nationalization is understandably scary to anybody who owns (or has an interest in) banks and other businesses.

Temporary Measures

Nationalizing the banks can be a temporary measure, and it happens when banks in financial trouble need rescuing. Temporary bank nationalizations are not unheard of in the United States: The FDIC steps in, takes control, and transfers the failed bank to another bank—often over a weekend.

When banks are insolvent, they go into receivership and get re-privatized when another bank purchases the failed bank’s assets. The period of government ownership is typically brief, so the bank assets become privately owned shortly after that. For most consumers, that system works quite well. Instead of losing your money in a bank failure, you’re protected by the federal government. In most cases, you’ll hardly notice when your bank fails.

In some cases, the U.S. government controls banks for a more extended period. In complicated situations, such as Indy Mac Bank during the financial crisis, the process can take several months or years.

Federally-insured credit unions, which are owned by their “members” (or the customers), have similar protection under NCUSIF insurance.

Larger Scale Nationalization

Most people have no problem with the government stepping in to clean up the occasional bank failure. But political debate starts to heat up when the topic turns toward more drastic measures, including:

  1. Widespread nationalization of all banks
  2. Nationalization of the nation’s largest banks
  3. Nationalizing other industries, such as healthcare

It’s unlikely that all banks will be nationalized in the U.S., but anything is possible. For now, such measures seem to be viewed as temporary—again, as part of a rescue during events like a financial crisis. Running banks would be a significant operational undertaking for the U.S. government (even if only the largest banks were nationalized).

Scenario number one is most likely only if an extremely top-down regime were to rule the nation. Scenario number two was proposed during the mortgage crisis for banks categorized as “too big to fail.” Those banks were deemed to create an excessive risk to the global economy and U.S. taxpayers. However, other measures, like higher capital requirements, helped to reduce the likelihood of catastrophic failures.

Ideology

Nationalizing an industry is controversial, particularly in the U.S. Developing nations have taken over industries during upheaval, but the U.S. tends to be a more hands-off environment. However, nationalization is possible whenever political forces make it acceptable.

For example, industries that cause widespread suffering and populist anger are at risk of being nationalized. During the mortgage crisis, banks were the “bad guy,” and it was easy for lawmakers to take control of certain institutions. Healthcare is another example where individuals see abuse, a lack of transparency, and great suffering, making it fertile ground for change—including potential nationalization.

Effects of Nationalization

Depending on your views, nationalization, or the threat of it, has several outcomes.

Executives

When banks are nationalized, stakeholders (including executives, with significant interests in the bank) lose money. Plus, executives with generous compensation packages may earn less. Those conditions could potentially discourage moral hazard, or excessive risky behavior that benefits executives at the expense of taxpayers.

Shareholders

Investors who profit from companies that take risk also lose out. Ideally, this discourages investors from putting money into risk-takers and makes it harder for those companies to raise capital.

Government Management

For better or worse, government agencies take over. Some argue that the government is ill-equipped to manage complex organizations and that politics can affect operations and management. Others say that taxpayers can ultimately save money by rescuing troubled banks and bringing them back to life (without letting all of the benefits go to shareholders and executives).

Article Sources

  1. The Brookings Institution. "Bank Nationalization: What Is It? Should We Do It?" Page 11. Accessed July 7, 2020.

  2. Federal Deposit Insurance Corporation. "When a Bank Fails - Facts for Depositors, Creditors, and Borrowers." Accessed July 7, 2020.

  3. Federal Reserve Board. "Financial Regulation Since the Crisis." Accessed July 7, 2020.

  4. Columbia Law Review. "The Privatization-Nationalization Cycle." Page 3. Accessed July 7, 2020.

  5. The Brookings Institution. "Bank Nationalization: What Is It? Should We Do It?" Page 12. Accessed July 7, 2020