Government Ownership of Banks: A Really Bad Idea

The financial crisis exists mostly because of government mistakes, particularly the Federal Reserve's easy-money policy, the corrupt system of subsidies from Fannie Mae and Freddie Mac, and various "affordable-housing" initiatives that coerced or lured banks into extending loans to people with poor credit.

These policies and others helped to create a bubble, and now the bubble has burst. Not surprisingly, politicians are using the resulting turmoil as an excuse to expand the power of government. The most troubling development is that the Treasury Department is becoming partial owners of banks -- in some cases by forcing banks to "sell" shares to the government.

The politicians say these steps are necessary to help the market. This is a rather breathtaking claim since the Dow Jones Industrial Average was well above 11,000 in September, when Treasury Secretary Hank Paulson announced that the economy was in trouble and that the government needed to intervene. Based on the stock market's response, it appears that investors wisely understand that the phrase, "I'm from the government and I'm here to help you," is a sign of big trouble.

The Administration's bumbling also has contributed to uncertainty. Markets have been whipsawed as policy makers lurch in one direction and then another. The Administration first argued that taxpayers should purchase so-called toxic assets from banks, but that plan has fallen out of favor and the Treasury Department is instead giving money to banks (or forcing them to accept money) in exchange for partial ownership. This is a rather dramatic change of direction, but the bailout legislation that passed Congress gave the executive branch a blank check, so there are no constraints on switching tactics.

So what does partial nationalization of banks mean? The good news is that this plan is more likely to achieve the stated goal of improving the financial position of banks. This is hardly a surprise. If the government seized hundreds of billions of dollars from taxpayers and gave that money to grocery stores or furniture companies, they also would have healthier balance sheets.