What Does Bank Nationalization Mean?

There has been talk in recent weeks about the possibility of the U.S. government nationalizing some struggling banks, like Bank of America or Citigroup. While Federal Reserve Chairman Ben Bernanke has said that is not the government's plan, political pundits and economic analysts aren't so sure.

As Bernanke faced the House Financial Services Committee in a recent hearing, he told Congress that nationalization "is when the government seizes the bank and zeros out the shareholders and begins to manage and run the bank. And, we don't plan anything like that." Yet American taxpayers are about to become the biggest single shareholders of Citigroup.

As the Obama administration prepares to put banks through a so-called "stress test," the end result could be a greater government stake in several banks. If a stress test reveals that a bank needs more capital to function properly, the government will step in to help. One form of that help could be converting preferred shares to common shares owned by the government. So, what is the difference between this and nationalizing banks?

Many economists have pointed to what is called the "Sweden Solution" as a model for bank nationalization. In the 1990s, banks in Sweden faced a similar crisis of toxic debt until the government swooped in and forced the banks to write down their bad debt. The government gave the banks money under rather strident conditions and eventually profited from their equity stakes in the banks.

The difference between the U.S. bank bailout currently underway and what took place in Sweden over a decade ago may be a matter of semantics. The latest term being bandied about is "zombie banks." A zombie bank is one that is more or less bankrupt, unable to cover their debts, and is essentially being kept alive by the government. Bernanke has said that he does not know of any zombie banks in the U.S. at this time. Many analysts, like New York Times columnist and Nobel Prize winner Paul Krugman, would argue that AIG is a perfect example of a zombie financial institution.

As Krugman said in a column this week, "So why has this zombie idea -- it keeps being killed, but it keeps coming back -- taken such a powerful grip? The answer, I fear, is that officials still aren't willing to face the facts. They don't want to face up to the dire state of major financial institutions because it's very hard to rescue an essentially insolvent bank without, at least temporarily, taking it over. And temporary nationalization is still, apparently, considered unthinkable."

Even Alan Greenspan, the former Federal Reserve chairman, has said that it's possible a temporary nationalization of some U.S. banks may be necessary. Proponents of nationalizing some of the big banks, like Krugman, make it sound very straightforward. He uses the Federal Deposit Insurance Corporation, which has had to seize hundreds of insolvent small banks. "When the F.D.I.C. seizes a bank, it takes over the bank's bad assets, pays off some of its debt, and resells the cleaned-up institution to private investors. And that's exactly what advocates of temporary nationalization want to see happen."

Unfortunately, few things are straightforward or easily resolved when it comes to the current economic crisis.

Ki graduated from the University of Texas in Austin. He maintains a website detailing Austin real estate. The site allows future home buyers to search for Austin homes in the Austin MLS.