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On nationalizing banks

I think it's wise to be wary of nationalization. It should be a last resort, and I've gotten a sense recently that a lot of people are talking about it awfully casually. Still, it's true that there are some benefits to nationalization, and one of them is that it allows us to avoid the problem of valuing and buying up toxic assets from troubled banks. If the government owns the whole bank, then the bad stuff can be easily hived off without any kind of valuation at all, and then left to sit for a while before it's sold off.

-- Kevin Drum

and gets comments like

First, from the perspective of national goals, the American financial and banking system has been a dismal failure, with real industries, most particularly capital goods, and public infrastructure, STARVED for funds for almost three decades now. Instead, the financial and banking system has supported ever increasing debt, and ever more complex derivatives based on that debt, none of which has done an iota of good for the real economy.

-- Tony Wikrent

The best way for the government to avoid the obvious outcome in such a situation is for the government to take over and run the bank: nationalization. Since the government has an interest in protecting its own liabilities, rather than maximizing shareholder value, the chances of crazy gambles will be minimized. In any case, since the government is taking virtually unlimited downside, it should by rights have all the upside as well -- i.e., ownership.

-- Felix Salmon

and gets some smart comments (David Merkel)

Debt-for equity cramdowns may not work in some cases because at larger banks the debt is usually at the holding company, and the bad assets are at the operating banks subsidiary. Better for the FDIC to force some sort of compromise where the operating subsidiary is made whole, while forcing holders of securities in the holding company (common, preferred, sub debt, sen debt) to face an uncertain future, while the healthy bank subsidiaries continue to operate.

Our biggest banks would identify their bad loans and foolish investments. And they would then pay a fee to a new state-backed insurer to protect themselves from losses over a certain level on these stinky assets.
But the banks would retain these bad assets on their balance sheets. They would not be transferred to a new toxic bank. We as taxpayers wouldn't own the stinky loans - though we would be liable for losses on them over a certain level

-- Robert Peston

Finally, Eugene F. Fama has the clearest mind:

The FDIC may simply shut the failed bank, auction its assets, and use the proceeds to pay off depositors and other liability holders in order of priority. If the market value of the failed bank's assets is less than its insured deposits, the FDIC supplements the bank's assets to pay off the insured deposits. If the FDIC charges appropriate premiums for deposit insurance, the insurance is a fair game and does not produce losses for taxpayers, at least on average.

There are many variants of FDIC intervention, but they typically have one common property. They solve the debt overhang problem. Non-insured debtors are paid off only to the extent that the market value of the assets of a failed bank exceeds its insured deposit liabilities. This means that any new equity capital injected after the reorganization increases the market value of assets and the market value of equity capital dollar for dollar.

And pithy:

The Fed's advantage over the Citis and Wamus: No shareholders, no reporting requirements, zero transparency, and no mark-to-market.

To quote Mel Brooks, "Its good to be the king . . ."

-- Barry Ritholz

Willem Buiter.

Note that the guarantee component of the Bank of America package (like the earlier insurance of/guarantee for $300bn worth of Citigroup toxic assets provided by the US Treasury) does not avoid the problem of valuing the toxic assets. The problem of determining a price or value for the illiquid assets stopped the TARP from being used as originally intended - for buying toxic assets from banks and in the process becoming a price and value revelation mechanism for illiquid assets. There is a valuation embedded in the guarantee or insurance offered to Bank of America and Citigroup: the state will compensate the banks if the value of the securities falls below a certain level. But the valuation is rather well hidden, and may not be revealed unless the guarantee is actually invoked. Also, guarantees are off-balance sheet, and politicians, like bankers, like that.

The bad bank would hold the toxic assets and collect the cash flows associated with it until a liquid market for these assets is re-established. This may never happen, in which case the bad bank would hold the toxic assets to maturity.

The publicly-owned banks would be reprivatised when financial markets stabilise and the economy recovers. It would be good if a better regulatory and supervisory regime for banks and other highly leveraged entities were in place by that time.

Ironically, by partially nationalising some of the banks, by making this injection of public capital expensive financially and as regards other conditionality, and by holding the threat of possible future (partial) nationalisation over the remaining banks, the authorities created an incentive structure that is biased strongly against bank lending, and against bank risk taking generally. The best escape from this unfortunate halfway house is to go to temporary full public ownership of all the banks. It would be cheap. It should not cost more than £50bn for the state to buy the rest of the UK high street banks. It could wait a while and get them even cheaper - possibly for nothing. But time is more precious than money in this case.

(via Jane J. Kim and Heidi Moore, 2009 Jan 22) WSJ: How will private-banking and brokerage-account customers be affected?
That depends on whether the government takes a short- or long-term view. If it intends to be a long-term owner, then it will probably sell off the brokerage, investment-banking and other auxiliary operations as nonessential to the core banking business. If, however, the government sees its step as a short-term fix to shore up the system temporarily, then it may hang on to such operations.

What other products and services might be affected?

If the government takes over a bank, management will be under even more pressure to cut costs. Expect more branch closings and poorer customer service. "Think of the bank as the DMV of the future, run by government employees who have little upward mobility," says Mr. Kaytes.

"I think we can expect that over time, the nationalized banks will be less open to innovation and new product development, more conservative in their approaches, and more constrained in their actions and subject to tighter scrutiny," says Jim Eckenrode, banking and payments research executive at TowerGroup.


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