How will partially nationalized banks behave?

by on October 9, 2008 at 1:05 pm in Economics | Permalink

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.

1 ZBicyclist October 9, 2008 at 1:14 pm

I thought this was a somewhat libertarian blog.

Here we are discussing how to implement socialism.

2 Andrew October 9, 2008 at 1:36 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…

3 Speedmaster October 9, 2008 at 2:11 pm

My guess is more than partly-politicized. ;-(

4 Andrew October 9, 2008 at 2:34 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

5 Tyler Cowen October 9, 2008 at 2:44 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.

6 Tom Hanna October 9, 2008 at 4:06 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.

7 Rob October 9, 2008 at 4:43 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.

8 otey October 9, 2008 at 5:46 pm

The government will ask what any shareholder asks. Maximize the value of my shares.

This isn’t that hard.

9 DanC October 9, 2008 at 6:32 pm

A good alternative view to nationalization

http://freakonomics.blogs.nytimes.com/tag/john-cochrane/

10 Luke Lea October 9, 2008 at 7:06 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.

11 ogmb October 9, 2008 at 8:03 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.

12 DJ Nanda October 9, 2008 at 8:24 pm

Classic Common Agency!

13 Gregory Rehmke October 10, 2008 at 12:30 am

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.

14 DanC October 10, 2008 at 2:09 am

Is Obama, and others, correct that a lack of regulation caused this problem. Fannie and Freedie have about 200 outside people assigned to regulate them, plus Congressional oversight. Or did the quasi public structure respond first to the political demands of Congress, then the financial demands of politically connected customers, and lastly to taxpayers. The chairman made about $10 million dollars – would he risk his job by getting Congressmen angry at him.

How do you design a regulatory system that is not political at it’s core?

What were lenders thinking when they made these loans? In my travels to San Diego, Las Vegas, Chicago and Miami I was amazed at the prices for housing. A co-op I had sold in Chicago had tripled in price in ten years, and that was a more rational market then some.

I asked one builder in Miami how many people in the country can actually afford all the million dollar plus condos that were being built. He just shrugged. I remember another builder in Arizona telling me how many of the high price homes were actually just large empty boxes. People living without furniture, or in some cases leasing furniture. Banks holding a million dollar mortgage on a home were the owners could not afford a coach.

This is getting off topic. But how did the incentives for these lenders get so out of whack? Greed didn’t cause it. As the Chicago Tribune wrote in an editorial blaming this crisis on greed is like blaming a plane crash on gravity. Greed is always in the market.

Were payoffs going on to lenders? I have heard stories about street gangs in Chicago flipping houses on paper for profit. Don’t know how true that is.

How did incentives get so out of whack and how will the government owning 20% change the incentives?

15 will October 15, 2008 at 3:06 pm

From what I understand, the government will receive preferred shares, which in general have no voting rights. The model then would be almost the opposite of what you are implying, with the government holding debt like securities, and the 80% stockholders still retaining their equity stake. Some dilution may occur still.

Comments on this entry are closed.

Previous post:

Next post: