“There are four basic approaches to cleaning up a banking system that is facing a systemic crisis: recapitalization of the banks, together with a purchase of their toxic assets by a government "bad bank"; recapitalization, together with government guarantees – after a first loss by the banks – of the toxic assets; private purchase of toxic assets with a government guarantee (the current US government plan); and outright nationalization (call it "government receivership" if you don't like the dirty N-word) of insolvent banks and their resale to the private sector after being cleaned.
Of the four options, the first three have serious flaws. In the "bad bank" model, the government may overpay for the bad assets, whose true value is uncertain. Even in the guarantee model there can be such implicit government over-payment (or an over-guarantee that is not properly priced by the fees that the government receives).
In the "bad bank" model, the government has the additional problem of managing all the bad assets that it purchased – a task for which it lacks expertise. And the very cumbersome US Treasury proposal – which combines removing toxic assets from banks' balance sheets while providing government guarantees – was so non-transparent and complicated that the markets dove as soon as it was announced.
Thus, paradoxically nationalization may be a more market-friendly solution: it wipes out common and preferred shareholders of clearly insolvent institutions, and possibly unsecured creditors if the insolvency is too large, while providing a fair upside to the tax-payer. ....
Nationalization also resolves the too-big-too-fail problem of banks that are systemically important, and that thus need to be rescued by the government at a high cost to taxpayers. Indeed, the problem has now grown larger, because the current approach has led weak banks to take over even weaker banks.
Merging zombie banks is like drunks trying to help each other stand up. JPMorgan's takeover of Bear Stearns and WaMu; Bank of America's takeover of Countrywide and Merrill Lynch; and Wells Fargo's takeover of Wachovia underscore the problem. With nationalization, the government can break up these financial monstrosities and sell them to private investors as smaller good banks.
Whereas Sweden adopted this approach successfully during its banking crisis in the early 1990's, the current US and British approach may end up producing Japanese-style zombie banks – never properly restructured and perpetuating a credit freeze.”
Nouriel Roubini, "Time to Nationalize Insolvent Banks", Project Syndicate (February 2009).
http://www.project-syndicate.org/commentary/roubini11/English
http://www.project-syndicate.org/contributor/1095
Professor Nouriel Roubini (1959-) teaches economics at the Stern School of Business, New York University and is Chairman of RGE Monitor, an economic consulting firm. He has wide experience in academia, the Federal Reserve, Council of Economic Advisors and Treasury, and international financial institutions. Roubini is also known as “Dr. Doom”, for his early and pessimistic warnings of an economic crisis that would engulf the U.S. and the world.
Had we from the beginning worked systematically to identify those banks that were insolvent from those that were weak from those that were satisfactory, and immediately closed down the insolvent ones and worked to save the weak ones, we would have had some hope of saving the situation. But we didn’t. Instead we followed several strategies to “try and save” the situation and avoid the losses entailed in shutting down failed banks while propping up weak ones. Money was thrown at the banks and efforts were made to put a floor under the price of toxic assets. As we did so, the bad banks ate good banks and toxic assets were spread further across the financial system. We created zombie banks that are now a bigger threat to the health of the economy than the insolvent banks of the past ever were.
We may now have no choice but to shut down them down by having the government take them over in some sense of the word. In the case of little banks, this is not a problem, as the FDIC has (unfortunately) lots of experience closing down small banks. But large banks are not really banks, or rather are much more than banks. Financial holding companies such as Citigroup are huge entities, really financial conglomerates with a myriad of different kinds of financial services under a umbrella of different sub-companies with a complex web of debts owed and debts due, all of which we need to be sorted out. The only ones that will come out ahead in any nationalization of the banks (I can see Professors Folsom and Davids cheering now -- just kidding) will be the lawyers. The rest of us will simply suffer, suffer, suffer in ways we cannot even anticipate because nationalizing big bank holding companies is far more complex and far more fraught with the possibility of the pain spreading far and wide than people realize.
Professor Roubini’s home page is http://pages.stern.nyu.edu/~nroubini/.
Thanks to Larry Willmore for the Tdj.
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