Today AIG sounded more like ‘Americans in Grief’ than ‘America’s International Grandiose’. Both WSJ and NYT had front page articles covering the big bad wolf and how it was consuming our hard-earned dollars faster than we can say kaboom. There is a large public debate on whether nationalization of banks and financial institutions is a smart idea or not, and for a change the public debate is actually not divided on party lines. As I write this entry, “we the people” already hold a 80% stake in AIG, and the Obama administration is continuing to be the faitful medic attending to the dying corpse. Nationalization, to me, is almost anti-capitalism and anti-free-market principals; but like countless others I have recently come to realize that free markets only work when they can self-regulate effectively, which is somewhat irnonical given that they only exist because of individuals’ greed.

Nationalization, at this stage, is almost necessitated in order to prevent further collapse of the financial institutions. AIG for one, is the largest insurer of other corporations’ balance sheet assets, and has been scraping together margin as those same assets decline some more every day. The other problem is the increasing premium on the scores of Credit Default Swaps that suddenly defy all traditional default-risk models. There was a excellent series or articles on WaPo a few weeks back (part 1, part 2) that I had to go and re-read to understand how we even got here.

Pondering about the question on nationalization, I had to but think back to India and how Indira Gandhi’s goverment comsumed all 14 of India’s largest banks in one fell swoop in 1969.  In a second act, the government nationalized the six next largest banks back in 1980. Today, out of the 88 commercial banks in India, 27 (the largest, including State Bank) note the Indian Government as the largest shareholder. To put in perspective, 75% of the country’s banking assets are in the hands of our trusted government. Do remember that India was and is still fairly socialist in terms of economic policies, and Indira Gandhi epitomized populism in her era by her aggressive expansion of the Government’s power. Looking back, there are several incentives of having a nationalized banking structure, and that is despite all the red tape and beareucracy that such a system would entail.

Nationalization for the most part eliminates the profit targeting and risky investmenting that most bankers embark on, making banking more accessible to more people, and regulatory oversight more achievable. Also to note is that the Reserve Bank of India, the counterpart of the US Fed is completely nationalized, unlike the Fed which is a quasi-autonomous entity with sometimes squemish objectives. Nouriel Roubini, a well-respected economist from my alma mater, NYU, has been pushing the nationalization idea for several weeks now and has become a staple of the news networks’ analysis. Roubini proposes that the government nationalize all the banks that are deemed insolved as per the Treasury’s ‘stress-test‘, and quickly separate the acquired assets into good and bad for easy disposal. Per Roubini, “Basically, we’re all Swedes now. We have used all our bullets, and the boogeyman is still coming. Let’s pull out the bazooka and be done with it.”

Like Roubini, I believe that the time has come for partial nationalization of the banking sector; the ‘bad bank’ scenario that has been doing its rounds for the last few weeks actually seems like a good deal at this time. The Fed and Treasury simply can’t make enough impact on the flow of credit in the markets the same way a nationalized bank can. Instead of continually bailing out financial institutions that are sinking money into their extremely diversified operations, the government should rather nationalize the depository units of the insolvent banks and auction off the remaining units. More than these measures, I believe it is time to reinstate the Glass-Steagall act, which although might force major restructuring in financial institutions, will provide the necessary confidence to the market (More on this later). The nationalization on Indian banks was not that bad an idea, even though they fluttered and faltered and are somewhat inept, they do serve as a major backbone and allow the government to control credit. The Indian banking industry does not need the same kind of life-support as American banks for that very reason. Depository institutions are the life-blood of a nation’s trade and well-being, and cannot be allowed to play roulette with the citizens money.