A profoundly bad idea; you can bank on it

Nationalizing banks would be even worse than the government's current foray into finance

With the government, under a Republican president, taking equity positions in banks as it has injected money into various financial institutions, the talk around Washington is whether, under a Democratic president, the government will go ahead with what seems to some the next logical step. Why not just nationalize certain banks, that is, have the government own and operate them?

Taxpayers are now the biggest shareholders in Bank of America, with about 6 percent of the stock, and in Citigroup, with 7.8 percent. And the government already has more influence than that small ownership interest might indicate, given that it has guaranteed to absorb losses from some of the banks' most toxic assets and is not the least bit shy about wanting to influence, if not dictate, bank lending policies.

Or, as House Speaker Nancy Pelosi put it in an interview Sunday, "Whatever you want to call it. If we are strengthening them, then the American people should get some of the upside of that strengthening. Some people call that nationalization."

Of course, she quickly said that she wasn't talking about total ownership, but she seemed clearly delighted that the subject of nationalization was even being discussed and suddenly seems semirespectable.

The idea of nationalizing banks, however, should not be even remotely respectable. It's hardly a novel idea. Some countries have nationalized banks, and the result is almost always loans made on the basis of political popularity or political influence rather than economic feasibility or potential for profit.

Banking is already one of the most heavily regulated industries in the country, and regulators and politicians already have a great deal of influence over banking decisions. Indeed, the housing bubble that precipitated the current recession was largely a result of investment vehicles linked to government pressure on banks to lend money to borrowers who in earlier times would not have qualified for mortgages, in the name of increasing homeownership and serving the "underserved." The notion is simply absurd that politicians and bureaucrats can direct investment better than those who actually have a personal stake in how those investments turn out.

Lawrence H. White, the F.A. Hayek Professor of Economic History at the University of Missouri-St. Louis, who has written three books on banking, told us that the banking industry in India was largely nationalized until quite recently. Those nationalized banks decided that information technology and the movie business were not good places to make loans. Those businesses had to raise much of their money elsewhere and turned out to be among the more profitable industries in India, contributing a great deal to that county's economic growth – despite the nationalized banks.

Many banks in France were nationalized at times in the past, and French banks developed a reputation for being uncompetitive, stodgy, unfriendly to consumers and slow to adopt new technology. Heavy government control of Japanese banks in the 1990s led to reluctance to close insolvent firms. The Japanese economy didn't start to come out of the doldrums until the government finally allowed a few insolvent banks to close, leading others to become more competitive and market-savvy.

As professor White put it, nationalized banks will "divert money to the most vote-productive uses rather than the most economically productive uses."

It's bad enough that the government has bailed out banks rather than letting them take their lumps in the marketplace for unwise decisions. Nationalizing banks would be disastrous.