The blogosphere is starting to realize how difficult it would be for the government to "take over" the largest banks, even if those banks are insolvent by various measures. Here is Justin Fox, who considers the size of Citi liabilities relative to FDIC assets. Ezra Klein considers the fate of the progressive agenda if a bank goes on the government's balance sheet and voters start to blame Obama for what they don't like about banks; the email he reproduces is excellent. Matt Yglesias considers the fiscal implications. Plus nationalization can prove contagious. A related issue (I forget where I saw the link) is whether it is legal to nationalize a multinational bank in light of varying national regulations.
That all said, it is an entirely coherent position to wish the government could take over the largest banks.
Here you will find Krugman defending the nationalization idea.
This is a two-way street. Take CDSs and CDOs. I’m someone who believes the the complexity argument and can’t be priced argument are wrong. Starting in November, I started posting that savvy investors like John Paulson were buying theses assets that couldn’t be priced, and that when the government seem to give up on buying them, the price went way down allowing these investors to start buying. Now, here today from Free Exchange:
http://www.economist.com/blogs/freeexchange/2009/03/the_uncertainty_regime.cfm
“I recently spoke with a quant whose job is pricing and selling mortgage-backed securities. I was surprised to hear how busy he has been; who is selling these things and buying them? He claimed the recent Moody’s downgrade meant that many institutional investors had to unload the securities off their books (due to provisions that nothing in their portfolio can be less than a particular investment grade) and realise the loss. The quant claimed some hedge funds are snapping them up as the influx of the securities on the market is bringing prices down even further. Still, bid ask spreads have been as large as 15%.
At the rate these securities are trading now (often less than 30 cents on the dollar), he claims that all the underlying mortgages could default and you could still make money on the security. So, other than liquidity issues, why isn’t everyone buying them? If prices are such that the securities will make a profit even with universal default, shouldn’t the market clear and we finally have a price on these things?
He claims the assumption of profitability is based on current conditions—even if you buy a mortgage-backed security for 20 cents on the dollar, you still can’t put a lower bound on its potential value because the probability of government intervention is high and what government might do can’t be forecasted. Until the government has a credible housing policy, no one will be able to assign a certain value to mortgage-backed securities.”
As near as I can tell, that’s what I’ve been posting for months, including John Paulson’s report on how to make money from them even when they blow up. Nevertheless, I never get an answer about this. All I read is: No one can price them, No one will buy them, etc.
As for nationalization, I’d be more impressed with the complexity argument and Citi if the people arguing this actually bothered to look at Citi’s plans going forward to see if they make any sense. There are two big problems:
1) Selling the assets, like Monex, Nikko Cordial, or even Banamex. It is conceivable that Citi could lose lots more money foolishly holding on to assets, or trying to keep Banamex at any cost, etc. Their only strategy is to dump these assets at some point. We’re providing a bridge loan to allow them to escape fire sale prices, but what happens if a number of these investments go bust in this downturn? Also, these businesses, as far as I know, run themselves. I’m open to proof that Pandit runs them all, but I’d like to see it.
My point is that I don’t actually see the risks of leaving things be actually discussed. This might be our only choice, but it is risky as well.
2) Foreign investors wanting their bonds honored as well as US bondholders. Frankly, I think that this is the big hangup. Many foreign investors, including China, have basically said that they believed that there was an implicit US government guarantee on their investments. In other words, they should be treated as US investors. From Zero Hedge:
http://zerohedge.blogspot.com/2009/03/why-citi-will-not-follow-in-lehmans.html
“Citigroup’s 10-K filing makes it clear why regulators appear committed to (or perhaps are stuck with) a strategy of supporting the full capital structure (including holding company debt), rather than subjecting the bank to the Lehman treatment. Citigroup has a daunting $1.9 trillion of assets on the balance sheet alone (not counting off-balance sheet exposure). The balance sheet is essentially supported by an uneasy alliance between the U.S. government and the company’s depositors and other creditors, since the market value of the equity is so depressed. Deposits totaled $774 billion at year end, including nearly $500 billion outside the U.S. In a liquidation of a U.S. insured depositary institution, the 10-K notes that U.S. deposits would have priority over deposits outside the U.S., as well as over parent company claims. But we can’t imagine the new administration will want to precipitate an international crisis over whose-deposits-get-paid-off-first.”
Another bridge loan to avoid facing an awful decision. But do we want to implicitly acknowledge this guarantee? It’s huge.
So, I’m fine with debating the merits and problems of seizure. It’s not even clear that we can seize Banamex. But I’d like to see realistic assessments of the risks of allowing Citi to continue operating as it is.
There are good arguments on both sides, and each side needs to be specific, in order that the issue gets fairly debated.
Re: Nationalization, Yes the responsible parties should pay, but there’s no way they can fully pay for the mess they made. Are all bondholders responsible? All equity holders? No, just the decisionmakers. You could give the decisionmakers the biggest haircut in the world. They don’t have enough hair to make the banks whole.
Nationalization is a moot point. We will be pumping massive amounts of money to recapitalize the banks, no matter which path we choose. While “fairness” is important, I’m not convinced it is anything like the most important issue at this juncture. In particular, if nationalization is too practically messy (maybe it is, maybe it isn’t), then that trumps any argument from fairness. Yeah, those suckers should pay, but their money is small potatoes to us at this point.
Is there any reason to support nationalization that I’m missing, beyond the ideas that:
(1) “Heads should roll” and responsible decisionmakers should be punished as much as possible,
(2) Bondholders and equityholders should in fairness be next on the chopping block, even if they didn’t make the bad decisions;
(3) Practically, nationalization could grease the wheels of getting popular support for gov’t to make the banks whole.
Is (2) even true? Suppose we cleaned out management. Why are equityholders responsible any more than bondholders? I imagine there’s some basic definition about equity vs. debt, but really. What if my grandmother has stock in Citi through a mutual fund? Does this make my grandmother responsible for the bank’s failure? Isn’t management the only truly responsible party?
Don,
The problem is not lack of proper valuation, it is that the proper valuation will make it clear that the banks are insolvent. The people that have been saying that nobody can value these are the govt and the banks, not other investors. I just wanted to put a fine point on your statements.
Now in terms of the details of the nationalization, we are long past the point when we can really debate the issue because the banks are undoubtedly insolvent, and only exist today because of capital guarantees by the U.S. government. Without this guarantee – either directly to the bank or systemically through AIG – the banks are unquestionably, undeniably insolvent and would have had to file Chapter 11.
As a result, we are past the stage of debating nationalization of the banks, but rather at the stage where we debate how to spinout these assets with the least amount of systemic disturbance, fairly, and in the least amount of time.
barbar,
good point on the price of the securities. Most of the bond/cds world works off of a range of prices and it is one of the biggest risks out there. The lack of liquidity on many of the issues was the reason that CDS took off in the first place. For a firm like Ford, where they have literally hundreds of issues, a CDS allows people to price the bond portion so much more efficiently. That is why these derivatives were so popular in the first place.
Hi Andrew,
I know at least two businesses that are in danger of going out of business and are laying off people due to banking and not business.
Also, more debt will not get us out of this mess, you are correct, but more money will. There needs to be more money in the world and less leverage.
In the prior leveraged times, the world economy in total was able to consume all of its output and still demand more. Why does the world economy require leverage to do this? It should not require leverage for the world to consume all that it can net produce. Tf we required leverage to consume it all before and and now the leverage is gone there is slack demand and decreasing prices, this must mean that more money is required in the world
Run banks or run on banks, that’s the question. If nobody (management, FDIC, Treasury or any other stakeholder) knows how to run a bank like Citi it’s time to run on the bank. The sooner the better…
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