During times of financial crisis, the U.S. government sometimes provides relief designed to stimulate the economy and prevent economic disasters. One result is that the government can end up playing a significant role in the fate of many banks. When the government does intercede, the topic of nationalizing banks often arises soon after, and the subject stirs lively debates.
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 of the business, and the previous owners (or shareholders) lose their investment.
Banks in the United States are typically businesses, not government agencies. The bank's owners might be stockholders, a family, a small group of people, or other investors. Nationalizing would give control of these banks to the government.
In nationalization, ownership and control transfers to the government, usually as a unilateral decision, meaning the government makes the decision, not the bank owners. A government might make a unilateral decision if, for example, a bank is at or on the brink of failure, the consequences of which could have rippling effects on the rest of the economy.
After nationalization, the previous owners no longer control the asset. If the asset has value — potentially generating income, or appreciating for sale at a profit— nationalization might understandably be a scary thought.
When nationalization occurs, the previous owners and managers often lose their ownership interest. However, individuals in management positions may end up keeping their jobs.
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 Federal Deposit Insurance Corporation (FDIC) steps in, takes control, and transfers ownership of the failed bank to another, healthy bank.
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, and the bank's assets become privately owned again shortly after. 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, because the FDIC is protecting your assets.
In some cases, the U.S. government controls banks for a more extended period. In complicated situations, such as with IndyMac Bank during the financial crisis, the process can take several months or years.
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, such as the nationalization of all banks, or nationalizing other industries, such as healthcare.
It’s unlikely that all banks will be nationalized in the U.S. Such actions are viewed as temporary, part of a rescue during events such as a financial crisis. And running banks would be a significant operational undertaking for the U.S. government, even if only the largest banks were nationalized. Nationalizing all banks is likely only if an extremely top-down regime were to rule the nation.
Nationalizing only the largest banks is a scenario that was proposed during the sub-prime 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, the use of other measures, such as higher capital requirements, instead helped to reduce the likelihood of catastrophic failures.
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, during the mortgage crisis, the actions of big banks (and their repercussions) drew the attention of lawmakers, who found it sensible to take control of certain institutions. Healthcare is another example where abuse and a lack of transparency has caused suffering, making nationalization seem like a potential solution.
Effects of Nationalization
Nationalization could have several outcomes, each of which could affect stakeholders in different ways.
When banks are nationalized, stakeholders (including executives, who have significant interests in the bank) lose money. Additionally, executives who currently have oversized compensation packages could earn less if they stick around after the transfer.
However, that could potentially discourage moral hazard, or the situation that arises when executives take risky actions that only have consequences for taxpayers.
Investors who profit from companies that take risks also lose out. Ideally, this discourages investors from putting money into risk-takers and makes it harder for those companies to raise capital.
Instead, 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).