Nationalise the Banks - International Social/Political

Nationalise the Banks
by Matthew Richardson and Nouriel Roubini via reed - Washington Post Sunday, Feb 15 2009, 7:32pm
international / social/political / other press

The subprime mortgage mess alone does not force our hand; the $1.2 trillion it involves is just the beginning of the problem. Another $7 trillion -- including commercial real estate loans, consumer credit-card debt and high-yield bonds and leveraged loans -- is at risk of losing much of its value. Then there are trillions more in high-grade corporate bonds and loans and jumbo prime mortgages, whose worth will also drop precipitously as the recession deepens and more firms and households default on their loans and mortgages.

Last year we predicted that losses by U.S. financial institutions would hit $1 trillion and possibly go as high as $2 trillion. We were accused of exaggerating. But since then, write-downs by U.S. banks have passed the $1 trillion mark, and now institutions such as the International Monetary Fund and Goldman Sachs predict losses of more than $2 trillion.

But if you think that $2 trillion is high, consider our latest estimates at the financial Web site RGE Monitor: They suggest that total losses on loans made by U.S. banks and the fall in the market value of the assets they are holding will reach about $3.6 trillion. The U.S. banking sector is exposed to half that figure, or $1.8 trillion. Even with the original federal bailout funds from last fall, the capital backing the banks' assets was only $1.4 trillion, leaving the U.S. banking system about $400 billion in the hole.

Two important parts of Geithner's plan are "stress testing" banks by poring over their books to separate viable institutions from bankrupt ones and establishing an investment fund with private and public money to purchase bad assets. These are necessary steps toward a healthy financial sector.

But unfortunately, the plan won't solve our financial woes, because it assumes that the system is solvent. If implemented fairly for current taxpayers (i.e., no more freebies in the form of underpriced equity, preferred shares, loan guarantees or insurance on assets), it will just confirm how bad things really are.

Nationalization is the only option that would permit us to solve the problem of toxic assets in an orderly fashion and finally allow lending to resume. Of course, the economy would still stink, but the death spiral we are in would end.

Nationalization -- call it "receivership" if that sounds more palatable -- won't be easy, but here is a set of principles for the government to go by:

First -- and this is by far the toughest step -- determine which banks are insolvent. Geithner's stress test would be helpful here. The government should start with the big banks that have outside debt, and it should determine which are solvent and which aren't in one fell swoop, to avoid panic. Otherwise, bringing down one big bank will start an immediate run on the equity and long-term debt of the others. It will be a rough ride, but the regulators must stay strong.

Second, immediately nationalize insolvent institutions. The equity holders will be wiped out, and long-term debt holders will have claims only after the depositors and other short-term creditors are paid off.

Third, once an institution is taken over, separate its assets into good ones and bad ones. The bad assets would be valued at current (albeit depressed) values. Again, as in Geithner's plan, private capital could purchase a fraction of those bad assets. As for the good assets, they would go private again, either through an IPO or a sale to a strategic buyer.

The proceeds from both these bad and good assets would first go to depositors and then to debt-holders, with some possible sharing with the government to cover administrative costs. If the depositors are paid off in full, then the government actually breaks even.

Fourth, merge all the remaining bad assets into one enterprise. The assets could be held to maturity or eventually sold off with the gains and risks accruing to the taxpayers.

The eventual outcome would be a healthy financial system with many new banks capitalized by good assets. Insolvent, too-big-to-fail banks would be broken up into smaller pieces less likely to threaten the whole financial system. Regulatory reforms would also be instituted to reduce the chances of costly future crises.

Nationalizing banks is not without precedent. In 1992, the Swedish government took over its insolvent banks, cleaned them up and reprivatized them. Obviously, the Swedish system was much smaller than the U.S. system. Moreover, some of the current U.S. financial institutions are significantly larger and more complex, making analysis difficult. And today's global capital markets make gaming the system easier than in 1992. But we believe that, if applied correctly, the Swedish solution will work here.

Sweden's restructuring agency was not an out-of-control bureaucracy; it delegated all the details of the cleanup to private bankers and managers hired by the government. The process was remarkably smooth.

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.

© 2009 The Washington Post Company

Many of the nation's largest banks are too sick to cure and the only way to clean up their balance sheets, saddled with as much as $10 trillion in toxic assets, is through nationalization, a growing number of economists said.

This drastic step, so far being resisted by the Obama administration, could wipe out shareholders and cause pain in the short run but spark the quickest rebound, the economists said.

"Paradoxically, nationalization may be a more market-friendly solution," said Nouriel Roubini, aka "Dr, Doom," chairman of RGE Monitor and an NYU economics professor. "It provides a fair upside to the taxpayer . . . by allowing the government to sell the assets to private investors after a cleanup of the bank."

Treasury Secretary Tim Geithner is still hoping for a private solution to the bank crisis - outlining a vague plan to draw out private capital to invest in the banks' toxic paper - but the problem may be too big to fix through asset purchases.

"It's clear there are divisions in the administration about where the financial bailout should be targeted as well as how much authority the government should gain over financial institutions," said Princeton professor Julian Zelizer.

Under the Geithner plan, a "stress test" would be administered to the ailing banks' balance sheets. The results, experts predict, will show a tremendous need to bolster Tier-1 Capital - most likely through common-stock purchases.

But the billions in additional capital injections will all but wipe out current common and preferred stockholders.

Geithner's alternative idea, of enticing private equity and hedge funds into purchasing the toxic paper through government loans, seems equally fraught with peril. Under this plan, Treasury would be empowering two totally unregulated entities - one of which recently brought us Bernie Madoff - to help bail out the banking industry.

If Washington were forced to nationalize several large banks, it would be best to take them over all at once to avoid a run on the weaker rivals, said Roubini.

Under such a plan, there would be no change for any bank customers and no deposits would be lost.

Some expecting at least a partial bank nationalization plan to emerge feel Geithner is not up to the task of solving the problem.

Quantum Fund co-founder Jim Rogers said Geithner, who was president of the New York Federal Reserve Bank, "has been dead wrong about everything for 15 years in a row," as was President Obama's economic advisor Lawrence Summers, who acted as Treasury Secretary under Pres. Clinton. "It is mind-boggling to me," Rogers said on CNBC.

"These guys have been wrong year after year after year consistently, and here they are making the same mistakes again."

Geithner is stuck with nationalization as a likely scenario because the US can't afford to fund a plan that will keep banks private - namely, buying up about $3 trillion more in toxic assets than they have spent so far.

Investors last week, showing little faith in Geithner's plan, drove down banking stocks deeper than the 4,9 percent drop in the S&P 500 Index over the last four trading days.

Citigroup fell 11.6 percent since Geithner announced his plan, Bank of America fell 19.2 percent, Wells Fargo dropped 17.3 percent, JPMorgan Chase declined 9.5 percent and American Express dipped 11.3 percent.

"The history of bubbles clearly shows that the significant consolidation of the financial sector is inevitable," said Richard Bernstein, strategist, Bank of America. "The latest Treasury program is simply another attempt to stymie the consolidation process," Bernstein added.

© 2009 NYP Holdings, Inc

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