Larry Summers on The March.

Today's economic policy must-reading is Ryan Lizza's profile of Larry Summers in the New Yorker, which covers a lot of political, personal and policy ground. While the whole thing is worth your time, I thought I'd highlight this defense of the administration's decision not to nationalize the banks, drawn from a memo by Summers.

The memo was divided into four sections. First, Summers explained that there was no legal authority to take over large bank-holding companies like Bank of America and Citigroup. Next, he pointed out that full nationalization of a financial institution might trigger systemic shocks, as investors retreated from other banks, creating exactly the kind of panic that nationalization was intended to prevent. (As [Obama economic official Gene] Sperling often argued, “You might come out and say, ‘I’m gonna take over Bank of America and Wells Fargo, but everybody else is safe!’ Maybe they believe you. And maybe they don’t. But if you get this wrong the Dow’s at thirty-five hundred! You’re the worst economic manager in the history of the United States!”)

Furthermore, Summers said, there was a medium-term risk that nationalized banks would lose value, in the same way that the act of foreclosure decreases the value of a home. Summers pointed to the example of Sweden, which was regularly cited by economists who favored nationalization. But Summers noted that Sweden didn’t nationalize for two and a half years, by which time the situation had become so severe—interest rates had reached a hundred per cent—that there were no other options. In addition, Nordbanken, the largest bank nationalized in Sweden, was already eighty per cent government-owned. Summers concluded by emphasizing that nationalization was a strategy that governments turn to only after it is very clear that nothing else can work.

The results of the stress tests showed that the banks were not in as dire shape as commonly believed. Most of the nineteen banks were able raise money privately. “It worked,” the Treasury official said. “People had money to put into banks. The nationalization crowd would have had the government putting all that money in.”

This is not to say that a government seizure of the banks would have been the wrong policy. However, Lizza cites Treasury Secretary Tim Geithner's dictum that "plan beats no plan" when discussing why the administration's critics failed to gain more traction. Last winter, a lot of advocates of a more direct government role did themselves a disservice by failing to explain specifically what the mechanics of such a move would be -- simply saying that the FDIC does it all the time does not answer the myriad questions surrounding the approach, especially when people in the FDIC were balking publicly at the idea. There was never a real answer to the "how" question of receivership.

-- Tim Fernholz