How We Nationalized America’s Banks

One of the great mysteries of the business world since the financial crisis has been why American banks have simply forked over huge sums in settlements rather than contest government charges that they were solely responsible for bringing on the housing crash.

Though estimates vary, the enormity of the sums in question is not in doubt. The Huffington Post says that big banks in the U.S. and Europe have paid at least $128 billion to regulators; the Wall Street Journal puts the figure at about $130 billion for the six largest U.S. banks alone. However you calculate the figure, it is clear that banks aren’t simply handing over pocket change to get regulators to go away.

At the time of the crisis, there was a sense in some quarters that the government should have pushed even harder. In 2009 Rahm Emanuel, then Obama’s chief of staff and the current, beleaguered mayor of Chicago, told an interviewer, “You never want a serious crisis to go to waste.” There was then a strain of thought on the political left that banks should have been nationalized rather than receiving what was often termed a bailout, though it was actually a backstop that was repaid and, eventually, made the government money.

A recent Wall Street Journal article solves the mystery of why banks kept paying and why regulators kept making them pay. The government didn’t “waste” the crisis at all. It used it to nationalize the banks; it just didn’t call it nationalization.

Instead, the government has aggressively inserted itself into banks’ boardrooms, which is where directors are supposed to represent shareholder interests above all. The Journal reported that members of the Federal Reserve and other regulators have been meeting with bank directors as frequently as every month, demanding to see detailed records of board meetings (or in some cases, attending those meetings) and holding directors responsible not merely for setting institutional policy, but for overseeing how it is carried out. In a few cases, though apparently only a few, directors have pushed back. As an independent member of the board of a large U.S. bank said, “A director isn’t management.”

But a director now may be held liable if the regulators aren’t satisfied. By overwhelming directors with regulatory demands backed by the implicit threat of ruinous legal action, the government has usurped bank boards’ power, effectively reducing them to management. This, in turn, reduces management to bureaucrats, whose job is to jump through whatever hoops regulators demand through their domination of the directors.

Not surprisingly, banks report that this increased scrutiny has made it difficult to recruit and retain board members. But the effects go further. The banks have effectively suffered a boardroom coup under another name. Executives get to keep their jobs and directors – at least those still willing to serve in this regime – retain their boardroom perks. Only the shareholders suffer direct financial injury. The rest of us suffer indirectly, since the thrust of the regulators’ demands has been to steer capital to politically favored destinations at the expense of the broader economy.

Under this de facto nationalization, the settlements forked over by banks at the expense of private shareholders are more properly viewed not as redress of malfeasance, but as dividends paid to the banks’ new beneficial owner: the government. Shareholder equity has effectively been seized just as thoroughly as was the case with Fannie Mae and Freddie Mac. In the case of those housing finance businesses, the government no longer merely demands repayment of sums it advanced, but instead hoovers all the profits that these ostensibly privately owned but government-backed entities generate.

Other than private investors, who might exercise their power to bring a shareholder derivative suit against directors they elect, there is nobody left to contest the regulatory boardroom coup. Even a shareholder suit, should one arise, has questionable chances of success. Regulators will simply assert that they are carrying out the Dodd-Frank reform legislation, whose sweeping oversight powers, they will plausibly claim, give them authority to dominate financial institutions’ management. The line between oversight and usurpation is very fine.

It is only now becoming clear that increased regulatory power amounted to nationalization, at least from the perspective of the Democrats who thought the government should have taken over the banks outright at the time of the crash. It turns out the crisis wasn’t wasted after all.