Will the government take over the banks?

THE BANKING crisis is back--and it's now so bad that the U.S. government may be compelled to once again nationalize some of the country's biggest financial institutions. It's the latest evidence that the current economic slump will become even more severe--and likely last for years.

Ground zero of the current financial crash is Citigroup, the huge conglomerate created a decade ago thanks to financial deregulation during the Clinton administration. Once hailed as a pacesetting "financial supermarket," Citigroup has become a vast sinkhole that swallowed $7.5 billion from the Abu Dhabi government's investment fund last year-- followed by $45 billion of U.S. taxpayers' money (not counting the $300 billion government guarantee against the banks' losses on dubious assets).

But all this money hasn't stabilized the situation--Citigroup lost $8.3 billion in the fourth quarter of 2008.

The main reason: like virtually every other major U.S. bank, it bought up enormous amounts of mortgages that were packaged into special bonds. These mortgage-backed securities became the basis for ever-greater speculation.

It was all hugely profitable while it lasted. But when the housing bust finally came, the value of those paper assets plunged, and the banks' paper profits from the housing boom soon vaporized.

Mortgage-related losses and other bad debts have made Citigroup technically insolvent. Management is desperately trying to raise cash by splitting the bank in two and selling off chunks of the company at fire-sale prices.

As economist and New York Times columnist Paul Krugman put it, Citigroup is a "zombie bank," kept afloat only by regular injections of government cash. Krugman's proposal: nationalize Citigroup and other failing banks, wiping out their shareholders and taking control, rather than prop up failed managers and banks' stock prices through endless streams of government money. Once the banks' balance sheets are cleaned up, Krugman argues, they could be sold off.

Writing about similar developments in Britain, Financial Times columnist Philip Stephens put it more bluntly: "I cannot think of a more popular policy than shooting the bankers and nationalizing the banks...Come to think of it, it could also be the way to get us out of this mess."

That mess keeps getting worse, too. Perhaps the most spectacular example is Bank of America (BoA). Just three months ago, BoA was hailed for avoiding Citigroup's mistakes. It was the very model, we were told, of a modern megabank after buying up mortgage lender Countrywide Financial and the Wall Street giant Merrill Lynch.

But Merrill's huge $15 billion loss in the fourth quarter of 2008 is swamping BoA. BoA tried to use the losses to get out of the merger it agreed to last year--but the Feds ordered them to complete the deal, according to the Wall Street Journal:

Bank of America was told in a telephone call from the federal government that it had no choice but to close on the purchase of Merrill, despite the mounting losses, according to another person familiar with company. To make the deal work, the government eventually provided $20 billion in additional capital and agreed to share losses on $118 billion in assets.

That money comes on top of the $25 billion that the government had earlier invested in BoA stock.

BoA and Citigroup are only the most egregious cases of crisis-ridden banks sucking in taxpayers' money. So one can be forgiven for asking the obvious question: Why hasn't the U.S. financial system been restored to health by a series of aggressive government bailouts?

The totals are staggering: $200 billion to take over mortgage lenders Fannie Mae and Freddie Mac; another $150 billion to nationalize the insurance giant AIG; the $750 billion Troubled Asset Relief Program (TARP) bank bailout, half of which has been spent; and the anything-goes effort by the Federal Reserve to flood banks with cash, including zero-percent loans and increasing its liabilities from $900 billion late September to more than $2.2 trillion in late December.

This unprecedented monetary transfusion hasn't worked, however, because the patient is still hemorrhaging. The banks have mostly used the government's money to stem losses on their balance sheets. The bankers remain unwilling--or unable--to make many loans, even though the Fed's measures have eased the pressure on key credit markets, including money markets and the market for short-term corporate loans, known as commercial paper.

UNDERLYING THE intensifying financial crisis is the rapidly deteriorating "real" economy.

Last September's failure of Wall Street investment bank Lehman Brothers turned a long-term credit squeeze into a credit freeze that brought the financial system to the brink of collapse. The lack of credit, in turn, exacerbated the normal cyclical downturn that followed the weak economic recovery of 2001-2007.

Rather than a "normal" recession--which would have been bad enough for workers hit by falling real wages and rising personal debt--the financial meltdown created what is now universally acknowledged as the worst economic crisis since the Great Depression.

The slump so far is still a long way from the worst of the 1930s depression, when production declined 47 percent, real gross domestic product fell 30 percent, and unemployment hit 25 percent.

But the recent economic statistics are ominous enough: a 7.8 percent plunge in U.S. industrial production in 2008. U.S. steelmakers, which enjoyed record profits in the first half of 2008, ended the year operating at just under half their capacity, compared with 88 percent a year earlier.

Such cutbacks led to the elimination of 2 million jobs throughout the economy as a whole in the last four months of 2008, leading to an unemployment rate of 7.2 percent. And those still on the job are facing outright cuts in their pay.

"Strapped U.S. companies, while continuing to slash their workforces, are deploying a once-rare tool to trim labor costs--pay cuts," the Wall Street Journal reported, pointing out that "the last time the U.S. had widespread wage cuts was during the Great Depression."

Unsurprisingly, consumers have responded to the crisis by dramatically cutting their spending, with retail sales in December down 9.8 percent from their level of a year ago.

The pullback by consumers has, in turn, hit corporate profits. Electronics retailer Circuit City, for example, filed for bankruptcy and then liquidated, eliminating 34,000 jobs. A more surprising case is Microsoft, which announced its first-ever layoffs January 22, affecting 5,000 people. Many other examples could be cited--and there are more to come.

All this spells yet more trouble for the banks. As businesses cut back or go under, the banks' commercial real-estate loans are going bad, particularly hitting regional banks that are already crippled by bad home mortgage loans. The Wall Street Journal reported:

[A]s bad as 2008 was, few are ready to say the worst is over. The troubles in the residential sector are expected to continue, while problems are just beginning for the other side of the real-estate market--office buildings, hotels, shopping malls and other commercial properties--as the recession starts to have an effect.

The expected wave of corporate bankruptcies will drag down the banks even more. Statistics show that the number of companies filing for bankruptcy in the third quarter of 2008 was 61 percent higher than a year earlier.

The same dynamic can be seen worldwide, with banks losing a combined $1 trillion in the crisis so far. Many more losses are to come, as banks in Europe unravel. The British government is being forced to consider nationalizing the entire banking system, and other European governments are likely to follow suit as the crisis spreads.

Meanwhile, in Asia, the collapse of demand in the U.S. and Europe has led to mass layoffs and factory closures, even in China, the rising industrial power of the last 20 years. In short, the major world economies are highly interdependent and are drawing one another deeper into the slump.

POLICYMAKERS ARE failing to keep up with the spread of this crisis.

In the U.S., Barack Obama is hoping that the proposed economic stimulus package before Congress, currently set at $825 billion, will curb the impact of the slump and lay the basis for recovery. But given the scale of the crisis, the proposal is badly underpowered. This is not only because of its inadequate size, but also because it includes $300 billion in tax cuts, which lack the economic punch of direct government spending on infrastructure and other projects.

At the same time, the Obama administration is asking Congress to approve the second $350 billion from the TARP fund. A pressing question is whether the money will be once again funneled into banks that refuse to lend to individuals and businesses, or whether it will be used to finance relief for homeowners facing foreclosure.

More generally, the recession--like every capitalist slump--poses the question of who will have to pay the cost of the crisis. Businesses will try to use the recession to take over one another, but they are united in attempting to make workers bear the brunt.

The bank rescue plan being floated by the Obama administration wouldn't change that dynamic. The proposal on the table would have the government buy up the banks' dodgy assets to create a "bad bank." This would allow the banks to restore their balance sheets, while the government did its best to get some return on the bad debt. As with the Bush administration's TARP, this plan would leave the banks' profits in private hands while socializing their losses--that is, sticking taxpayers with the bill.

Nationalization of the banks is the only rational solution to the crisis--but not with the aim of simply returning them to private hands.

A financial system controlled by a tiny minority of the superrich has turned a recession into a worldwide economic catastrophe. Democratic control of the financial system by working people would be a step toward building a rational economy aimed at meeting the needs of the whole of society.