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How will partially nationalized banks behave?
This is a question about models, not a question about the real world.
We are used to invoking shareholder unanimity theorems, whether they are justified or not. But say the U.S. government owns twenty percent of each major bank. Exactly what instructions do they give the management? ("Hey, guys, just get stuff going again!"?) Presumably the twenty percent shareholder wants something different, and more in line with the public interest, than the desires of the remaining eighty percent. Are we to assume that the twenty percent wins out? Can managers be sued for violating their fiduciary responsibilities? Does the twenty percent explicitly tell the managers to do something other than maximize profit? What if the eighty percent votes to override them?
What are control rights worth in these situations?
You might argue that the mere fact of recapitalizing the bank will cause the eighty percent to want what the government shareholder wants. That is not in general true, especially if the government is pulling its capital back out at some point.
You might argue that the government involvement is a kind of insurance and it makes the older equity claims more like debt (insurance on the downside but loss of some potential upside gains). The newly neutered "debtholders" still might not want the bank to be very active, as evidenced by the stagnant nature of some explicit current debt markets.
I hear this recurring voice: "Hey, you guys, just get stuff going again!" It's an odd basis for corporate governance.
I am not sure what is the proper way to model this set-up.
Addendum: Greg Mankiw proposes non-voting shares.
Posted by Tyler Cowen on October 9, 2008 at 01:05 PM in Economics | Permalink
Comments
I thought this was a somewhat libertarian blog.
Here we are discussing how to implement socialism.
Posted by: ZBicyclist at Oct 9, 2008 1:14:24 PM
The government has the ability to control bank activity through regulation. They do not need voting shares for control.
Posted by: fusion at Oct 9, 2008 1:27:36 PM
Tyler, what are you doing in the UK? Are you speaking somewhere? Where can the loyal MR reader see you?!
And I know it's the wrong post, but like they said below: don't listen to the Daily Mail...
Posted by: Andrew at Oct 9, 2008 1:36:06 PM
Of course, this entire discussion is based on a 20% share. How likely is this going to be the case? If a bank is declared insolvent, any capital injection to make the bank solvent wipes out the previous shareholders, does it not?
Capital injections into solvent banks might not raise ownership over 20%, but then solvent banks don't need the capital injections by current capital ratios. I can tell you this, as a private shareholder, I would not want the government as a partner in the enterprise without a payoff.
Posted by: Yancey Ward at Oct 9, 2008 1:37:44 PM
My guess is more than partly-politicized. ;-(
Posted by: Speedmaster at Oct 9, 2008 2:11:45 PM
The core problem is that none of the managers who we've relied upon to run these banks for the past ten years have any idea how to make money running a bank except by inventing and selling new types of securities.
What we need is a new group of managers who are going to be content with slower growth, smaller profit margins, smaller bonuses, and less leverage.
But is there anybody on Wall Street still in that group?
Posted by: Michael F. Martin at Oct 9, 2008 2:34:03 PM
As it turns out, The Paulson Plan is really the Treasury secretary's post-retirement investment letter geared to market timing.
"Secretary Paulson said that it "will be several weeks before our first purchase." As shown in the chart below, when the TARP plan was first announced in September, that $700 billion was equal to less than 40% of the S&P 500 Financial sector's market cap. Today, that $700 billion represents over 55% of the sector's market cap. At this rate, by the time the Treasury opens up its wallet and starts spending that $700 billion, they might be able to buy the entire sector!"
http://bespokeinvest.typepad.com/bespoke/2008/10/700-billion-and.html
Posted by: Andrew at Oct 9, 2008 2:34:16 PM
I thought they were going to buy non-voting preferreds with some kind of special seniority?
Posted by: anonymous at Oct 9, 2008 2:39:02 PM
1. If regulation can get the banking system going, let's just have that regulation do its work now.
2. Alas, Alex and I are not speaking here.
3. I am not suggesting Daily Mail is a good paper, but it does reflect what a big segment of the electorate thinks and that suffices for the point I was making by citing it.
Posted by: Tyler Cowen at Oct 9, 2008 2:44:14 PM
Management gets messages from hostile takeovers.
Typically an urgent priority mail is sent to shareholders telling them that under no circumstances should they tender their shares as the offer does not represent the true value of the company.
The shareholders then all send in their shares, the hostile guys vote the shares and replace the management.
If the government is a shareholder, I imagine they'd send in their shares too.
A good deal is a good deal.
Posted by: Ron Hardin at Oct 9, 2008 3:35:43 PM
The discussion from Treasury is about a 2% to 5% stake. In the nature of government, I suppose that could easily end up at 20% in some cases, but not across the board.
More importantly, it's also about buying preferred stock, which usually doesn't carry voting rights. Perhaps warrants might be included or the stock might be convertible, but I don't see a Treasury Secretary exercising out of the money warrants - throwing away money - just to vote at an annual meeting.
Posted by: Tom Hanna at Oct 9, 2008 4:06:25 PM
What if the 20% is able to solve a coordination problem because of its ownership of 20% of all of the other banks? Perhaps it would be in the interest of the 80%, even as they might define it, that the 20% overrule them.
Posted by: dWj at Oct 9, 2008 4:12:42 PM
Seems to me that if the government purchased 20% of a company, the makeup of the other 80% stake would likely change rather significantly. If I owned shares in a bank and the government took such a large stake, I would make the assumption that the government will likely change the focus of the management away from profit maximization and toward the "public good." Under this belief, I would sell my shares on the open market, presumably to someone that wanted to become partners in the enterprise with the U.S. Government.
Posted by: Rob at Oct 9, 2008 4:43:06 PM
The stupid Paulson bill provided for NON-VOTING stock so the purchases will give the government zero governance. Paulson protecting his tribe again.
Posted by: spider42000 at Oct 9, 2008 4:49:31 PM
The government will ask what any shareholder asks. Maximize the value of my shares.
This isn't that hard.
Posted by: otey at Oct 9, 2008 5:46:08 PM
Here's a question in a reverse sense: If I'm going to lend to a partially government owned bank (not just a "nominally government sponsored enterprise" like Fannie or Freddie, but literally partially owned) won't I give it a lower interest rate because I have a built in expectation that the government will back their debts?
Through the course of this whole affair, the government has actually been committing itself to expanding the number of debts and obligations that it is willing to back in the event of a failure or collapse rather than reducing such exposures. Yet, almost everyone agrees that the backing of Fannie and Freddie and the resulting disequilibrium was the problem.
How is this not just pouring gas on a fire?
We have FDIC insurance to protect retail bank accounts. We have unemployment to support those losing their jobs (and in this case many of those losing their jobs just received bonuses larger than most people's annual incomes) and training programs to help them find new ones. What is needed is to allow capital to reallocate itself. That requires to government to get out of the way.
If the government wants to spend $700 Billion it should perhaps fix some of these bridges that are about to collapse or the fact the I-95 seems to need to be repaved every three years. How about shipping terminal security or hiring more troops to help end the war in Iraq and/or Afghanistan? How about expanding english language training for new immigrants so that they can become productive members of society and buy new homes more quickly?
All of the current efforts are attempts at bolstering and salvaging a market built on lies and deceit.
The only business that is to big to fail here is the US Treasury and we sure seem to be working really hard at making that a reality.
Posted by: Sam Wilson at Oct 9, 2008 6:00:41 PM
A good alternative view to nationalization
http://freakonomics.blogs.nytimes.com/tag/john-cochrane/
Posted by: DanC at Oct 9, 2008 6:32:02 PM
"The government will ask what any shareholder asks. Maximize the value of my shares."
No. If the government owns shares of each company then maximizing the profits of one may not necessarily maximize the profits of all (prisoner's dilemma). In that case government will say: Maximize the value of the sector.
Posted by: assman at Oct 9, 2008 6:43:33 PM
Fuck your models. They are a big part of what got us into trouble in the first place. "Beware quants bearing formulas," in the immortal words of Warren Buffet. Economics is an art, not a science. You will notice that Roubini uses intuition, logic, and common sense to arrive at a correct analysis of our situation, as did Keynes before him. Human behavior cannot be described mathematically, and never will be.
Posted by: Luke Lea at Oct 9, 2008 7:06:45 PM
Nationailized banks, wow this is a very very very very bad idea.
I'm was in the Title/Deed industry (car titles/house titles) for years and I got a very good grasp of how bad the government operates. I can just see it now, the bank lender who will try to do as little as possible, the bank teller who can't count, the bank manager who is a moron but knows how to climb the government ladder, and of course, the one lender who is trying to help (don't worry, this hard working lender will quit out of frustration). Banks loans being halted by a typo, bank forms being misplaced by incompetent interns, and of course calling 20 different agencies to get a bank loan approved.
Posted by: torris187 at Oct 9, 2008 7:26:34 PM
"Most of all, caveat emptor -- these are a matters for buyers and sellers, not regulators. Nobody else gets hurt if you buy a lousy mortgage pool. The government does not need to write a new rule every time someone buys a rotten tomato. Investors will demand the right transparency, complexity, and risk-sharing or monitoring of mortgage pools. That is, unless they get bailed out and learn to count on that instead! The history of the mortgage market is a grand story of bringing credit to people who need it, upon the removal of layer after layer well-intended but counterproductive "protective" regulation." -- John Cochrane, 2007
John Cochrane's opinion is worth less than Lehman Brothers stock these days.
Posted by: ogmb at Oct 9, 2008 8:03:20 PM
Classic Common Agency!
Posted by: DJ Nanda at Oct 9, 2008 8:23:53 PM
Classic Common Agency!
Posted by: DJ Nanda at Oct 9, 2008 8:24:24 PM
John Cochrane in brief
Banks mad a lot of bad loans
Banks lack capital to lend
Need to recapitalize banks
Let bad banks fail, wipe out shareholders, mark down assets, marry operations to new capital
Let Fed increase liquidity
Too many firms depend on short term debt, government can carry this debt
(BTW I was taught in my first finance class about the dangers of dependence on short term debt to finance operations in either the public or private sector, because an unexpected minor event can become a major problems. What are they teaching now?)
Letting banks fail is not the end of the world, this is not the 1930's
Politicians may try to buy off connected institutions. Don't do it.
Current treasury plan will not work.
Treasury assumes they can lift the value of mortgages, but unlikely to do it.
Buying bad debt from banks is the same as just giving them money, really won't affect value of assets they hold.
Steps to protect against foreclosures will make matters worse.
So I say
Let the worst banks fail. Force mergers with healthy firms and use the bailout money to help the new healthier banks recapitalize. Offer tax incentives etc on the S&L model.
Give current homeowners looking at foreclosure the opportunity to get fixed rate loans for 35 years. Increase the ability to deduct mortgage interest for the first five years of the loan if they occupy the home. Tax credit for people who buy foreclosed homes.
John Cochrane in 2007 clearly underestimated the effect of government incentives to make bad loans.
Why did the transparency on these loans get so bad? Or were they transparent and just a giant ponzi scheme.
Data on the root cause is confusing
Posted by: DanC at Oct 9, 2008 11:09:11 PM
Why not have the federal government invest enough to "earn" the corporate tax banks are obligated to pay the the federal government? So the corporate tax can be eliminated and government would receive via a dividend what it has otherwise received by taxing profits. The Federal government is already a "silent investor" in banks by virtue of confiscating a percentage of their profits.
Posted by: Gregory Rehmke at Oct 10, 2008 12:30:09 AM
