Impending Nationalization of US Banks

Or should the government just say, "We're going to buy you up so we don't have to keep dumping money into you"?

There is this question of nationalization that keeps coming up. When the government actually owns these banks, it becomes responsible for all the liabilities of the banks. Supposing the government goes in and replaces the equity holders and says now these are government-owned banks. Then the government becomes responsible to all the debt holders who otherwise have made losses. In other words, with a nationalization, what you get is a transfer of wealth from the taxpayer to all the bondholders who earlier were dependent on the private bank to repay them. Now [they] can depend on the full faith and credit of the government to repay them.

Why do so many economists think we should do this now?

Well, I think some of it is driven by the sense that if we don't nationalize, then these equity holders in the banks are getting a free ride where the bank can be run with government protection " where the debt of the banks is insured, the equity holders get all the upside, the government gets nothing for it.

We've been talking about the banks as though they are a monolithic body. But in fact, there's a lot of variation in the health of one bank versus another. How do you tell which banks are worst off, which banks are doing pretty well and what the difference is?

This is a problem. We don't know, which is why the government has suggested that it will go in and do what it calls stress tests. You go in and you try and find out what is the value of the bank under the worst-case scenario. And then you decide whether it's worth saving by putting in more money, or whether it should be broken up and sold in pieces, or whether it should be merged with another bank. The real question that the government hasn't made any statements on, partly because this is a very sensitive question, is what will it do when it finds out that the bank actually is dead when it does these stress tests?

Bank nationalisation gains ground with Republicans

By Edward Luce and Krishna Guha

Published: February 17 2009 19:44 | Last updated: February 18 2009 21:57

Long regarded in the US as a folly of Europeans, nationalisation is gaining rapid acceptance among Washington opinion-formers " and not just with Alan Greenspan, former Federal Reserve chairman. Perhaps stranger still, many of those talking about nationalising banks are Republicans.

Lindsey Graham, the Republican senator for South Carolina, says that many of his colleagues, including John McCain, the defeated presidential candidate, agree with his view that nationalisation of some banks should be “on the table”.

Mr Graham says that people across the US accept his argument that it is untenable to keep throwing good money after bad into institutions such as Citigroup and Bank of America, which now have a lower net value than the amount of public funds they have received.

“You should not get caught up on a word [nationalisation],” he told the Financial Times in an interview. “I would argue that we cannot be ideologically a little bit pregnant. It doesn’t matter what you call it, but we can’t keep on funding these zombie banks [without gaining public control]. That’s what the Japanese did.”

Barack Obama, the president, who has tried to avoid panicking lawmakers and markets by entertaining the idea, has moved more towards what he calls the “Swedish model” " an approach backed strongly by Mr Graham. In the early 1990s Sweden nationalised its banking sector then auctioned banks having cleaned up balance sheets. “In limited circumstances the Swedish model makes sense for the US,” says Mr Graham.

Mr Obama last weekend made clear he was leaning more towards the Swedish model than to the piecemeal approach taken in Japan, which many would argue is the direction US public policy appears to be heading.

“They [the Japanese] sort of papered things over,” Mr Obama said. “They never really bit the bullet . . . and so you never got credit flowing the way it should have, and the bad assets in their system just corroded the economy for a long period of time.”

Administration officials acknowledge that the rescue plan unveiled by Tim Geithner, Treasury secretary, last week could result in the temporary nationalisation of some weak banks.

The plan sets out a framework for revealing the extent of the likely credit losses facing banks. Most private sector analysts believe the exercise will reveal that some banks have large capital shortfalls.

Policymakers acknowledge that if this is indeed the case, it will be difficult for those with the largest shortfalls to raise the required equity from the markets, in which case the government would probably have to take temporary control. Moreover, while nationalisation remains taboo in some political circles it is increasingly openly discussed among past and present economic policymakers of all leanings.

“In this country nationalisation of some banks " not the whole banking sector " should be a last resort, but it should definitely now be on the table,” said David Walker, president of the Peterson Foundation and a former senior official in the George W. Bush administration.

The time for biting the bullet may also be fast approaching.

In early April, big institutions will publish their first-quarter results. If the intervening Treasury stress tests have not by then revealed the true state of their balance sheets, then their first-quarter results may do so.

“The first week in April " that’s when the children’s party is over,” says Chris Whalen, co-founder of Institutional Risk Analytics. “That is when the obvious will become apparent.”

The Obama administration remains opposed to federal control. Mr Geithner last week said: “Governments are terrible managers of bad assets.”

Others say he may eventually face no choice. “The danger we face is a Freddie Mac/Fannie Mae scenario where government gives the banking sector guarantees and then socialises the losses,” says Adam Posen, an economist. “That’s the worst thing we could do.”

Copyright The Financial Times Limited 2009

Sen. Charles Schumer (D-N.Y.) believes that failed "zombie" banks, no matter what their size, should be taken over by the government, which should then wipe out shareholders, fire management, clean up the banks and quickly resell them into the marketplace. Such a move, he cautioned, should come only if the "stress tests" being conducted by Treasury Secretary Timothy Geithner determine a bank to be insolvent.

WASHINGTON " The White House on Friday insisted it's not trying to take over two ailing financial institutions, even as stocks tumbled again. On Wall Street, talk of nationalization of Citigroup Inc., and Bank of America Corp., prompted investors to continue to balk, worried that the government would have to take control and wipe out shareholders in the process.

Citigroup fell 20 percent, while Bank of America fell 12 percent in afternoon trading but also came off their lowest levels.

"This administration continues to strongly believe that a privately held banking system is the correct way to go, ensuring that they are regulated sufficiently by this government," White House press secretary Robert Gibbs said when asked about nationalizing the banks.

"That's been our belief for quite some time, and we continue to have that," Gibbs said.

Investors have shown decreasing confidence that U.S. banks can right themselves. Citigroup and Bank of America have already received significant help from taxpayers as the government has rushed in to try to save the financial sector, which has been choked by bad assets and seen the flow of credit shrink.

The speculation about the two banks' future continued to take a direct toll on the market.

Gibbs was pressed for more details on his answer " specifically whether Obama would not nationalize banks. He said it was hard for him to be any clearer.

When a reporter suggested Gibbs could do that by saying point bank that Obama would never nationalize banks, Gibbs would not make that statement, but emphasized: "I think I was very clear about the system that this country has and will continue to have."

It doesn't really matter, once it DOES happen, Wall Street will panic like you've never seen.

It doesn't really matter, once it DOES happen, Wall Street will panic like you've never seen.

Perhaps someone could explain to me why we don't just let these poorly run banks go into bankruptcy/failure? Is there something special about banks?

National Government certainly doesn't get involved everytime some business fails...Instead a judge steps in, assists the company to divest itself of bad assets, reorganize as necessary, and the company either disappears, or starts anew (without the dead baggage). Why must the US "buy the assets nobody wants"? Allow the bank to sell them for whatever they can get under the supervision of a bankruptcy judge...

Restructure, revamp, under a judge's supervision and if appropriate, put back into private interest as soon as possible. No need for Govt to buy anything....