Tuesday, February 17, 2009

Is Nationalization the Answer?

The growing consensus among financial experts and economists who still have some credibility left is that stimulus packages and bailouts are only having limited effect in the near-term, and are destined to fail in the intermediate-term.

While this is no surprise to anyone in possession of their own thoughts, those operating from corrupted textbooks are now finally starting to understand that the only other legitimate option is for these failed institutions to go bankrupt.

Nouriel Roubini was the latest to take to the idea. Bloggers Yves Smith of Naked Capitalism and Calculated Risk both support it in one form or another. Many others are on board.

Of course, "bankruptcy" is a dirty word. It implies that something new would have to be constructed to replace the old. This is dangerous territory for closed minds. They'd rather see certain parts of our financial system salvaged, thus enabling the same crooked system to return and perpetrate the same problems all over again. So they have come up with another term: "Nationalization."

I suppose they're on the right track. Even if they're going in the wrong direction. Still, that's a giant step forward from their "of another solar system" ideas most have given us previously. For that, I give them my applause.

For most, the term "nationalization" has connotations of military dictators confiscating foreign interests in a misguided attempt to return it "to the people." Fret not, the proposals going forward are nothing of the sort. No sane person would want the big banks. Not even power hungry government. I doubt even Barney Frank or Nancy Pelosi would be foolish enough to take ownership of the banks in an attempt to do the lending themselves. But maybe I'm giving them too much credit.

In effect, "nationalization" as it is being proposed is merely a synonym for "bankruptcy." To that end, I welcome it with open arms. The proposed plan would:

- be done unilaterally and without warning
- wipe out common share holders
- wipe out preferred share holders
- guarantee depositors (likely only to a certain limit)
- leave bondholders with the scraps (which in most cases would be nothing)
- cleaned up banks would then be re-privatized

To be sure, it's not just a matter of taking a pill and expecting things to be better right away. It's more like an enema. Uncomfortable. Unpleasant. Even painful for some...or so I'm told. There will be some big time consequences and an enormous amount of deleveraging would immediately result. Pension funds would be forced to accept the reality that their lopsided bets on juicy dividend paying financials would receive a goose-egg. Hedge funds would be stuck with derivatives that have experienced "credit events" but will find that there is no counterparty to pay up. Most of them would go under too.

Surely doing something like this would likely see a sizable crash in world stock markets, a further flight out of real estate assets, and a dizzying spike in unemployment.

But that is going to happen anyway.

So I like this plan for a few reasons:

1. It comes close to addressing the fact that these assets are not worth nearly what we're told
2. It punishes those that took risks and rewards those that did not with lower prices
3. It gets the bulk of deleveraging out of the way sooner, rather than dragging the process out over decades (ie. Japan 90's and US 30's)
4. It accelerates the uncovering of another enormous bubble yet to pop - pension funds

Unfortunately, I highly doubt any of this is a politically acceptable possibility. It wreaks of "short-term pain for long-term gain." That is not a language spoken in political capitals anywhere, let alone Washington where they're already looking forward to the next election (mid-terms 2010).

Frankly, this is the same sort of process that needs to take place in the auto makers, airlines, newspapers, and many other dead or dying industries. More needs to be done, of course. Repealing legal tender laws, for example. But liquidation is a start.

If the prices are low enough, competent people will take over the assets and rebuild the companies. Some of them may not come back (like the late, great US piano industry - a very good read, btw), but at least resources will be freed up to positively invest in something useful, thus creating employment).

It all reminds me of battles I used to have with my old late 90's PC. It would get so overloaded and so slow, that simply loading one page would take over a minute. No matter what I did, that stupid hourglass would pop up. Each action I took would take longer, and longer, and longer. And then... crash. Any unsaved information was lost forever. On a few occasions, after being forced to go nuclear and press the power button, the worst would happen: the blue screen of death.

If only I had been a little more proactive. Restarting the computer every once in a while. Making backups of information and reinstalling Windows. So much wasted time swearing and cursing could have been saved. I probably could have got another 2 years use out of that machine, had I only done the proper maintenance.

Let's be proactive.

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mike.montchalin said...

This Bankruptcy-Through-Nationalization-Talk assumes it is government's role. It isn't, but let's roll with it for a bit.

Is government the best decider of which banks are solvent and which aren't? Roubini thinks that government (i.e. Barney Frank, Nancy Pelosi, & hirelings) would be the best deciders, by "poring over their books to separate viable institutions from bankrupt ones...," as though it were a mechanical administrative task they (or their hireling) were capable of.

Really, the question of solvency is best not left to the government. It should be left to bank creditors and depositors. They have a financial interest in the outcome and will make the best decision.

Roubini & Richardson think government is best suited to resolve the toxic assets prolem. Wrong again. In spite of the name, toxic assets have some value. The owners of toxic assets are much better suited for assessing their value than Frank, Pelosi, & hirelings. After nationalization, the government would wantonly jetison these assets at taxpayer expense.

"Second," Roubini & Richardson are all to anxious to wipe out institution's equity by fiat. It's just plain unfair to the stockholders.

"Third," after Frank, Pelosi, & hirelings have sorted the good assets from the bad assets, the government would return the remnants to private ownership through an IPO or to their favorite "strategic buyer."

Everything about Bankruptcy-Through-Nationalization-Talk stinks. And that is why I deleted Roubini from my Bookmarks.

Matt Stiles said...


Of course, you are absolutely right. I don't want government to have anything to do with the economy. Nothing. But allowing a market-based liquidation is not something that will happen with the ideologues in power. Unless something revolutionary happens in American politics, government will be de facto owners of nearly every industry within a year. Incremental bailouts will ensure that.

My point is that liquidation needs to occur. There are obviously better ways to achieve that than by government decree. But in my opinion, it is better and cheaper if done wrongly than not done at all.

mike.montchalin said...


Thanks for the response.

I know where you stand. It is just that I get irritated by those OTHERS who think markets will function better if regulated.

The big name bloggers have an unbridled faith in 'the authorities' and 'regulation.' It is as though they have never thought it through, "Who are the authorities? And what are their regulations?"

If they would just realize that the the-government is Barney Frank & Nancy Pelosi, ......and that regulators are their hirelings and that 'government will be de facto owners of nearly every industry within a year,' we could all have a good laugh.

mannfm11 said...

Banking has been nationalized since March 9, 1933 and the risks have been put on the people of the US to the benefit of the big shareholders of the big banks. The NY Banks along with BAC have been immune to any kind of financial discipline at least since the 1960's, as they have repeatedly been allowed to operate below statuatory capital. Back in the 1980's, they didn't blink about closing major banks in Texas while these big banks were many times broker. I believe we are reaping the effect of decades of sweeping this stuff under the rug.

When I mention Texas, don't confuse the S&L mess, which was a creation of Congress with banking. There are many times more losses in HELOC's in Wells Fargo than there were losses in the entire banking system here. There were many schemes of accounting that allowed for recognition of unearned interest to be counted as capital, thus allowing for massive extention of credit that should have never happened. The shareholders of such institutions need to be wiped out to serve as a reminder of what moral hazards are all about. The taxpayer is going to get the bill one way or the other. FDIC insurance should have never been allowed, that is what nationalization is.

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