Here is my latest column, excerpt:
The second set of solutions involves taking control of insolvent banks, either by nationalizing them or declaring them bankrupt. In the past, the Federal Deposit Insurance Corporation has used the model of rapidly shuttering failed banks, and it has usually worked.
Many
analysts cite Swedish bank nationalization, from the early 1990s, as a
model, because the Swedes later reprivatized these banks and resumed
economic growth.
But Sweden nationalized only two banks. And the
Swedish banks were much smaller and easier to run than the largest
United States bank holding companies, which combine a wide range of
complex international businesses, commercial paper operations, derivatives trading and counterparty commitments.
It
is quite possible that the reputation of a nationalized bank would be
so impaired that it would incur even greater losses as its web of
commercial dealings collapsed. These far-reaching commitments are a
reason that the F.D.I.C. model of rapid shutdowns cannot be applied so
easily here.
The most obvious problem with nationalization is the
risk of contagion. If the government wipes out equity holders at some
banks, why would investors want to put money into healthier but still
marginal institutions? A small number of planned nationalizations could
thus lead to a much larger number of undesired nationalizations.
On top of that, the government doesn’t have the expertise to run large bank holding companies like Citigroup.
There is the danger that caretaker managers, with bureaucratic
incentives, will never return the banks to profitability. And
restrictions on executive pay, already enacted into law, will make it hard to hire the necessary talent.
In
the meantime, there would be increasing pressure to politicize lending
decisions – for instance, by requiring loans to the ailing automobile
industry. Talk of taxpayers capturing an “upside” is probably
unrealistic.
The plight of the American International Group,
the giant insurer, provides a cautionary tale. The government has
already effectively nationalized A.I.G., but after a government
commitment of $150 billion, the company’s losses continue to mount, and
there is no simple way to either manage it or split it up. If the
government cannot run that bailout very well, how can it run major
banks and nurse them back to profitability?
Nationalization
also puts bank debts on the balance sheet of the government without
restoring bank solvency. Once the government takes over, it is hard to
reorganize the debts of these companies without damaging the
government’s own creditworthiness and spreading the insolvency to bank
creditors. Yet if the banks are insolvent, paying off the creditors may
cost trillions.
It is becoming increasingly clear that the question is not whether to nationalize but rather whether we can afford to make whole long-term bank creditors. Megan McArdle has some thoughts. How much do we gain by transferring the losses away from banks and toward Europeans, insurance companies, and pension funds? If the worst-case scenarios really are true — and they may be — that is the next question on tap. It is of course a very ugly question.
Tyler, in your post’s title you ask why the banking sector is hard to fix. Unfortunately, your column focuses on the three approaches to fix the banks but does not answer the question you ask. Indeed to answer your question one has to look at the political forces in play, at least to set the objectives of any plan to fix the banks. Your discussion of the three approaches is limited to how to restore solvency as a prerequisite for banks to resume their lending function. But if you look at what happened in the many banking crises of the past 30 years, you will see that your first objective should be to reassure that the problem will not occur again (this is what I call the flow problem). In the current crisis, the only way to provide this reassurance is to breakdown all big financial institutions (banks and others) that have been regarded “too big to fail”. This is why I suggested in a comment to one your many posts on financial crisis the breakdown of Citibank and the liquidation of Citigroup in case it doesn’t pay quickly all the money that has received from government (these actions are to solve the stock problem). Moreover, I suggested that Robert Rubin should be responsible for doing both jobs because he is the one that knows more about the holding company and the bank, and he’s also one that benefited a lot from their performance in the past 10 years; in addition, he’s close to BHO and his Dream Team. The same should be done with AIG and a few other large banks. I’m sure that FDIC can take care of the other banks. It’s time for specific proposals.
“Sorry, but all of the other creditors get a haircut.”
Jeff, how do you do that and not create another Lehman Brothers situation? If you give Citi’s creditors a haircut, the effect will be bigger than Lehman’s bankruptcy. And then how do you avoid having uninsured depositors remove all their money from any potentially troubled bank, creating a massive bank run? How do you keep credit flowing to any big bank — no one’s going to lend to a major bank if they think the government could take it over at any moment and write them down?
There is no reason why a corporate bond should not get a haircut. These are not treasury bonds at no point was it promised that they would be equivalent to treasury bonds which was precisely the reason why they give a better rate of return. Anyone who claims otherwise is talking his book and asking for taxpayers to redeem his losses. The only risk these bonds had ( for which they yielded better than treasuries ) is that the corporation could go incur losses in which case they would get paid less, when that is happening these hippocrats want a bailout ?
I found the following quote very illuminating, and it clearly foreshadows the future in the US:
> it seems to me everyone’s fighting over accounting at this point, deciding who should be the winners and the losers, or maybe it’s the losers versus the really big losers, for deals already completed
i agree with this, as far as blogs go. most of the blogs are just about moral outrage, which is another way of saying ‘i am a victim! listen to me! i want to assign blame!’
however, there is a real ticking time bomb here and the depth of the crisis will in part be determined by the response to the crisis. for instance there are cycles like the following: losses at banks are driven by mortgage defaults which are driven by layoffs which are driven by corporate bankruptcies which are driven by lack of credit which is driven by losses at banks. how deeply this cycle cuts will depend on what gets propped up and how.
Perhaps it’s time to consider the 100% solution. Have the FED monetize all outstanding demand deposits, then require 100% reserves against these deposits. This would have an immediate positive impact on bank balance sheets, without the inflationary danger inherent in pumping up reserves.
E. Barandiaren, Although the Peronists did institute a 100% reserve requirement, it was used, as you say to politically control the allocation of credit. This was effected by simultaneously nationalizing these deposits. This made the central bank the sole supplier of credit. That is not what I am suggesting. I am suggesting monetizing demand deposits, instituting a 100% reserve requirement, but keeping the deposits private. What do you mean by “a financial problem not a monetary problem”? By financial problem do you mean bank insolvency? Because that is precisely what the 100% solution helps. As you say, the banks’ deposits would fall by the amount of the demand deposits monetized. This is because they would cease to be deposits as traditionally defined (they would be on the order of bailments, and hence would not appear on a balance sheet). Since deposits are liabilities for banks, this will lower liabilities by the amount of the demand deposits while lowering assets only by the present reserve held against them. The end result being a much more solvent banking system.
It seems like the root of the problem is that these banks are holding lots of assets whose value is very uncertain. This makes their creditors nervous as well, which infects whole system. Furthermore, we may not be reasonably certain about the value of the assets for years.
The solution seems to be to take over such banks and (a) guarantee the liabilities (b) put in a caretaker (c) sell off everything that the market can put a reasonable price on, and (d) hang onto the rest until it can be sold at reasonable prices.
There’s a limit to how fast the market can absorb this, so selling things off may take years, but eventually we can use the market to put a price on everything.
Guaranteeing the liabilities will probably be a loss for the government, but since the most uncertain assets will be sold last, it might not be known for a long time. To reduce the price while also reducing uncertainty, perhaps the guarantee could for less than face value.
Anders Aslund denies that the Sweden nationalized its banks (“Sweden did not nationalize its banks. It was Norway that did”) and says they went the “bad bank” route.
Business activity picks up when it is clearly profitable going forward. The sunk cost losses of the past won’t stop it, no matter how large they are.
But if the losses aren’t recognized and segregated, it can’t be clear what will be profitable going forward, so even if you pour boatloads of new capital in you get a zombie.
Here and now it may be unpleasant to have bank bondowners take losses — Barney Frank just said in the FT that he doesn’t want “good people” and endowments and pension funds to do so, which may show the real political hold-up — but somebody has to take them, and the shareholders are already wiped out. Who else is left?
What Anderson said.
If one thing is clear, it’s that the massive compensation paid to bank management did not in fact lead to the banks being well-run. Would the guy they could have hired for a fraction of the pay have done worse? Was that even possible?
Torris, how does making an insolvent entity pay money have any effect? Please explain. Does Scotland put the owners and directors personally on the hook?
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