Danger of nationalizing banks

NYTimes columnist Thomas Friedman makes an excellent point his is post yesterday that the nationalization of banks will create a perverse incentive for financial operations within those banks. All of a sudden, the interests of the President and Congress have to be represented in all bank operating and loan decisions. Friedman says:

There is a fine line between risk-taking and recklessness. Risk-taking drives innovation; recklessness drives over a cliff. In recent years, we had way too much of the latter. We are paying a huge price for that, and we need a correction. But how do we do that without becoming so risk-averse that start-ups and emerging economies can’t get capital because banks with the government as a shareholder become exceedingly cautious. Let’s imagine this scene: You are the president of one of these banks in which the government has taken a position. One day two young Stanford grads walk in your door. One is named Larry, and the other is named Sergey. They each are wearing jeans and a T-shirt. They tell you that they have this thing called a “search engine,” and they are naming it ââ?¬â?? get this ââ?¬â?? “Google.” They tell you to type in any word in this box on a computer screen and ââ?¬â?? get this ââ?¬â?? hit a button labeled “I’m Feeling Lucky.” Up comes a bunch of Web sites related to that word. Their start-up, which they are operating out of their dorm room, has exhausted its venture capital. They need a loan. What are you going to say to Larry and Sergey as the president of the bank? “Boys, this is very interesting. But I have the U.S. Treasury as my biggest shareholder today, and if you think I’m going to put money into something called ‘Google,’ with a key called ‘I’m Feeling Lucky,’ you’re fresh outta luck. Can you imagine me explaining that to a Congressional committee if you guys go bust?” And then what happens if the next day the congressman from Palo Alto, who happens to be on the House banking committee, calls you, the bank president, and says: “I understand you turned down my boys, Larry and Sergey. Maybe you haven’t been told, but I am one of your shareholders ââ?¬â?? and right now, I’m not feeling very lucky. You get my drift?” Maybe nothing like this will ever happen. Maybe it’s just my imagination.

No its not your imagination Mr. Friedman. This is a very viable situation. Legislators are notorious for this kind of behavior and we do not have a climate in Washington that will not seek to exploit this new financial-governmental relationship. And lets not forget the moral hazard these banks now have, not only can they count on the government to bailout them out in the future, but the government is now an owner so the government’s bailout will be covering federal interests, not just interfering in the market place. Read all of the Friedman article here.