The Road to Bank Nationalization

Last week, seven major corporations announced major layoffs, adding 72,000 to the unemployed. At the same time, lending by the big banks fell. With falling demand for loans, it is little wonder that President Obama described the national economic situation as "worsening day by day." Clearly, we are heading into a deepening and severe recession that is spreading worldwide.

As the reckless speculation of the major money center banks became clear in the second half of 2008, there was resistance to rescue efforts. However, the perceived wisdom was that these banks were too large to fail. Congress approved the $700 billion TARP to rescue them and the financial system. Now, there is growing demand by politicians for the banks to lend, in the face of falling loan demand. Clearly, a Democrat Congress is intent upon using Wall Street to dispense taxpayer funds to Main Street. This is socialism and strikes at the very heart of the 'American Way' of free enterprise.

Three major questions arise. Firstly, can the banking system be used to dispense cash to un-creditworthy citizens? Secondly, should the free-market banking system be used for political purposes? Thirdly, can the American government afford to bailout the collapsing economy and banking system simultaneously?

Acknowledging Tim Geithner's vow to employ "credit action on a dramatic scale", there is little doubt that the new Treasury Secretary thinks the banking system not only can, but will, be used to push taxpayer funds into the Main Street economy. If so, would this not necessitate nationalization?

The original TARP was designed to 'rescue' the banking system by relieving it of depreciating toxic assets. Subsequently, the TARP was used to inject capital into the main money center banks. So far, despite its enormous size, the TARP appears to have failed.

Contrary to political hopes, the banks are seen too have used the TARP selfishly (but rationally) to bolster their own capital and pay their own executives, whilst making fewer loans.

There is now an increasing specter of a massive bank failure, despite the TARP. As a result, there is growing pressure to nationalize the banks, as is being done in Europe. So far, Americans have resisted this option, but with Bank of America (BAC) now trading below $5.00 per share, the temptation is growing.

In a recession, falling loan demand and deteriorating credit worthiness result in fewer loans worth making. There is mounting pressure, especially from Democrats, for banks to make 'social' or imprudent loans. Such actions are practicable only if the banks are nationalized.

Most Americans are firm believers in freedom and its economic progeny, the free enterprise system. But, under the cover of entitlement programs, increasingly large numbers of Americans are dependent, directly or indirectly, upon the Government.

In short, socialism is already alive in America, but is being extended, via the banking system, to become the dominant political force.

Citi (C) and Bank of America, two of the three most important money market banks are technically insolvent. Yet, each has received $45 billion in TARP funds.

These two banks have total exposure of some $78 trillion to derivatives. Most importantly, they have almost $6 trillion of exposure to highly toxic Credit Default Swaps. Even JP Morgan (JPM) has more than $9 trillion of exposure to these assets.

The Government TARP and stimulus packages now add up to some $3 trillion. Already, they have caused political consternation and pose serious challenges to America's credit rating and ability to extend further its towering debts, without crowding out viable corporate borrowing. What will happen when all of the private bank liabilities get thrown on top?

The money center banks render the TARP and, indeed, the total financing ability of the U.S. Government almost insignificant. In short, they have become too big to bail out.

It appears that America and the world are staring into the face of financial collapse, depression and eventual hyperinflation. Little wonder that, despite the growing evidence of recession, gold is rising in price.

Comments

[Novice6:]

Nice writeup Mr. Browne. Certainly BAC is in trouble, but I'm not sure exactly what the share price means at this point. The private debt market sector is innovative, creative, and not as smart as it thinks it is; adolescent. Now dad, not a great example of fiscal responsibility, has to clean up the mess.

Feb 08 07:19 AM

[slingeland:]

It seems that it would be better if the government would resurrect the resolution trust company which would buy the "bad" securities from the banks against payment of half the value as of 12/31/08 in cash and the other half in stock in the RTC with the government retaining voting control. This way the valuation becomes less of a problem; all the banks have a stake in the success of this venture, the government control future valuations and can decide whether to cancel the loan or sell it at a reduced rate. The RTC can also act as a clearing house for the credit default swaps.

Feb 08 07:38 AM

[Ranchr:]

A little disclosure here might help me evaluate the motivation for this article. Without that I can only suspect and suggest the author may want to cover early Monday.

By the way, my personal banker at BAC told me he has never been so busy writing new loans and they are all to 740 Beacons and above.

You may also want to look back and see what Lewis said about needing more than they already have; what they already have is grandfathered from any TARP2 rule changes; and, if you look at the timing of the second infusion of money and the $118 billion of guaranties, I suspect they knew this would be coming and got BAC covered before the old administration took the last train out of Dodge.

You'll all may remember the little Glow-Worm song from mid-last century... Cover little shorty, cover cover...

Feb 08 07:51 AM

[RRG:]

"socialism is already alive in America"

Indeed, the losses have been nationalized across the back of working American`s and the gains have been privatized amongst a select few.

Yes, socialism is alive and well in America, and those select few are doing everything that can to make sure that the broken model keeps filling their coffers.

Feb 08 11:35 AM

[Duke Wong:]

I read a lot of articles about the amount of toxic credit, most of them said it would be around few trillion dollars. Is there any way to know more precised number?
I concern if the toxic was too high comparing with amount of bailout then how would it work? Does government know it? If they knew, then why they're doing it?

Feb 08 12:44 PM

[fireball:]

if the accounts are fdic insured would it be so terrible to let bad banks (include other bad businesses) die and clear the way for the few who behaved wisely to prosper and grow to fill the vacumn. that goes double for the auto industry and the uaw. how about letting the innovaters rise if they have a good product? clear the old dead trees and let young healthy growth begin.
maybe keep government out of it. lawyers are the lowest lifeform. the only thing worse is lawyer turned politician. i don't expect them to make good business decisions.
i have seen the arguments about only govt. could provide the interstate system, public education, the space program, etcetera. there is and was enormous waste and abuse. even in these undertakings the private sector would have been worried about the bottom line and preventing waste. education could use the stimulous of the private sector and competition. it seems to be failing so the bar keeps dropping. some may get uppset by the notion that the space program and interstate system could have been done better by private enterprise. it wasn't tried so we can't know. i will concede that the interstate system was an act of national defense for rapid troop movement and was appropriate for it's day.

Feb 08 06:34 PM

[arten2:]

I'm afraid the gist of this article is correct, in that we are headed for further nationalization of the country's financial system - no matter what euphemisms Mr. Geithner is going to give this word when he lays out the Treasury/Fed plan to the public on Tuesday morning.

My disagreement with John Browne rests in the highly pessimistic, not to say sardonically disgusted, manner in which he views the very idea of "nationalism". Leaving aside all the programs created by and smoothly run by our government's bureaucrats - since relying upon them to justify taking over our banking system has become a cliche - the immensity of this current problem is so overwhelming that the finest economists in the Western world are reaching no consensus whatsoever on how we should proceed. The EU is looking to us to design a rational plan, as England, Ireland, Germany, and Italy have financial systems teetering on the brink of disaster - despite the fact that England, for example, has in fact nationalized three large banks already.

But European culture will accept total nationalization, as each country has dealt with it before and emerged whole after trying times. Our culture has no experience with any part of the private sector being taken over by the government and so we are repelled by its very notion without attempting to think about the possibility of there being any redeeming qualities contained in such a wrenching phenomenon.

Nevertheless, we are on the way toward rationalizing the exisiting chaos. In due time, after the troubled assets are sold back to the private sector (with a highly unscientific percentage of each pooled security deemed valueless) and the banks, now solvent again, operate as they used to with dull predictability, we will look back and conclude that our government has done the right thing - actually the only thing it could have done - and we will see private enterprise fulfilling itself again. And these ain't empty words........

Feb 08 07:46 PM

[Deehena:]

A little live socialism should be quite welcome compared to the corpse of libertarianism that failed so miserably.

Feb 08 08:47 PM

[max12345:]

Could someone please help to more properly define "nationalization" and systematically analyze its various implications? If a government owns 51% of the shares of an asset (a Bank for instance) does that mean that asset is "nationalized"? And how would the ownership or control be different if the government only owned 49%? Or how about 99%? Or is something nationalized only if the government owns absolutely 100% of it?

For instance the U.K. government now owns about 80% of the shares in the Royal Bank of Scotland which in turn also has come under Lloyds TSB. Is RBS: a) fully nationalized; b) partially nationalized or c) not nationalized at all since not 100% owned by the U.K. government?

And if the government only owns let's say 30% of the shares in any company or asset how would that be very different for the small shareholder (or even the institutional shareholder) from the alternative scenario where the original founding family or original owner of the business still owns that same 30%? Would they be looking out for number one more or less than the government?

Another aspect that I think could use some better explanation is the so called 78 trillion of "exposure" to derivatives and the 6 trillion "exposure" to "highly toxic Credit Default Swaps" by Bank of America and Citi. Both these figures sound staggering and duly alarming.

But unless one clarifies what "exposure" actually means and its precise implications (and non-implications) the statement could easily prove to be either meaningless or at least not nearly as alarming.

For instance, I am a citizen of planet earth and I am therefore "exposed" to all the poisons, crimes, wars, and all the other imaginable ills of the planet. Yet I can mostly avoid or navigate through the above ills and dangers unscathed and enjoy good health and may even be very prosperous prosperous today or tomorrow.

Let's try to be just as specific as possible and avoid potentially alarmist language or tendentious insinuations unless they are 100% grounded in reality. Do Citi and Bank of America really risk losing 78 trillion dollars?

If so, since the whole World is exposed to Citi and Bank of America, the whole World may just as well pack up and move to Mars and leave planet earth to be "nationalized" and made "socialist" by whomever is still foolish enough to have stayed around.

Feb 09 07:58 AM

[arten2:]

max12345, you bring up questions that economists, mathematicians, world government representatives, and even thinking politicians are mulling over and trying to give answers to. Let me deal with only one of your keen puzzlements.

Put simply, as I understand it, a company (banks, in this case) is nationalized when the government seizes total control and wipes out the interests of its shareholders. Common shares, dividends, preferred dividends, junior debt, and senior debt are all rendered valueless. Given this pure definition, the Royal Bank of Scotland - while 80% is now "owned" by the government - has not, in fact, been nationalized. In this case it is almost certain that shareholders will not receive common or preferred dividends, but junior and senior debt holders still have a good chance of receiving interest on their bond holdings.

If this is true, then all those claiming that RBS has been nationalized are misusing the term. While it is all a question of degree [common and preferred shareholders will complain their company has been nationalized, but junior and senior debt holders will disagree - until the day arrives, if it does, that even they see no interest payment credited to their account(s)].

Let's say, however, that RBS gets truly nationalized. This state of affairs, though, is not intended to last forever: the British government has told RBS that its 80% stake will be returned to the private sector when its cash infusion is paid back at an annualized rate between 10-14%. This may never happen, of course, as the bank may never again make enough money to repay the government. But it might. So there is a caveat thrown in that would mitigate the harshness of the government's takeover. When Chavez nationalized Venezuela's oil industry, somehow he left out the footnote that they would again be privatized should certain conditions be met.

You wrote a very well-thought out serious of questions.

Feb 09 01:10 PM

[max12345:]

Hello Arten2 thank you very much for your reply to the issues and questions I had raised. I found your reply interesting and useful. (though, as you say, you responded only to the issue of nationalization / privatization)

And so whoever also will respond clearly to the other issue of the 78 trillion "shortfall" (or deep hole) for Citi and B of A will -at the very least- deserve the co-pilot seat on the spaceship I personally will be piloting to Mars with the rest of the World aboard.

A bit more seriously now, I think the definition of nationalization you set out above (after your.. "put simply as I understand it") is indeed the most commonly understood definition. And it's pretty much the way I had understood it too. But I can't seem to find an "official" -and also universal and thorough- definition of "nationalization" (and importantly all its precise implications) though probably one exists somewhere and might even be close to the commonly understood definition, or understanding, you describe.

One thing is for sure though, nationalization also seems to be -if not by definition - at least by common understanding or by perception and favored interpretation, a definite bogey-man. In its converse (privatization) typically private investors pay something for the public enterprise which is being privatized. Unless of course they are Russian oligarchs-in-waiting in which case they simply appropriate it through corruption or assorted mafia tactics.

Presumably an entity's nationalizing government would not necessarily have to "wipe out" the current shareholders but might compensate them with something or leave them holding a bit of equity? (even though the government would get "full control"...and this whether temporarily or permanently)

That is, nationalization doesn't necessarily have to mean theft by the government, just as privatization of a public entity doesn't necessarily have to call for thievery by those private investors who take it over.
(though both the above have occurred in practice and on multiple occasions)

So (maybe) rather than considering either "privatization" or "nationalization" (and their respective return routes if any are actually available) as necessarily and invariably either good or bad, it's probably important to look at all the circumstances and conditions and very significantly at the "legal and regulatory environments or frameworks" into which companies (or banks) are either being privatized, nationalized, reprivatized, or re-nationalized.

One key aspect in my own mind that probably supersedes all of this back and forth either practical or theoretical ownership, is whether the entity in question is in fact being (or is later going to be) managed properly or not.

Private ownership -at least recently- does not (per se) seem to have guaranteed good management. Of course this does not mean that public ownership will or would.

For private ownership to result in good management requires
real competition and real other market forces and signals operating on managements and staffs. (cozy and un-transparent situations hardly ever result in good management) (just as multi-million dollar "bonuses"
are equally unlikely to result in good management)

And for public ownership to work requires the very same things or well functioning and effective surrogates. In either case, transparency, accountability (to something or to someone) seem to be common elements that would seem to be indispensable to "good management" in any context.

Focus on accountability, transparency, rule of law, independent oversight, effective regulation, institutions for checks and balances, and maybe freedom and independence of the specialized press (wait a minute this is starting to look like a primer in good governance!) are probably the most important elements to induce or coax out good management.

In normal times, private ownership in a democratic system tends to
be much more likely to yield up those variables than public ownership in a non-democratic system. A really good question to ask right now is why such a grotesque set of failures occurred recently (and why Mr. Made - Off was not the only to have Made Off in one sense or another)

Feb 10 11:39 AM

[Jason Rines...:]

Really good comments


On Feb 08 06:34 PM fireball wrote:

> if the accounts are fdic insured would it be so terrible to let bad
> banks (include other bad businesses) die and clear the way for the
> few who behaved wisely to prosper and grow to fill the vacumn. that
> goes double for the auto industry and the uaw. how about letting
> the innovaters rise if they have a good product? clear the old dead
> trees and let young healthy growth begin.
> maybe keep government out of it. lawyers are the lowest lifeform.
> the only thing worse is lawyer turned politician. i don't expect
> them to make good business decisions.
> i have seen the arguments about only govt. could provide the interstate
> system, public education, the space program, etcetera. there is and
> was enormous waste and abuse. even in these undertakings the private
> sector would have been worried about the bottom line and preventing
> waste. education could use the stimulous of the private sector and
> competition. it seems to be failing so the bar keeps dropping. some
> may get uppset by the notion that the space program and interstate
> system could have been done better by private enterprise. it wasn't
> tried so we can't know. i will concede that the interstate system
> was an act of national defense for rapid troop movement and was appropriate
> for it's day.

Feb 11 12:15 PM

[Jason Rines...:]

Don't beam me up yet but let me share what I know. The $78 T is tied into brokerage fees that amount to 2%. When Bear Stearns was liquidated, it was 1.75% of broker fees that were settled out of the CDS and CDO's. Let's carry forward this math to a $78 T and say that $1.6 T are fees that the banking system does not want to eat. While the public has earn trillions being thrown around like peppermint wafers, reality is that $1.6 T is a MASSIVE number in and of itself. That is theft at the end of the day to me on a massive scale, or if you prefer you could say that this was corporate malfeasance at least. A number of executives and politicians bribed got 2% fees already. The other counter party with the 2% is screaming foul and unwilling to eat the fees and of course, holds some political blackmail cards now. The taxpayer is directly going to pay the $1.6 T so roughly less then a thousand people can now have two indoor tennis courts, two yachts and 20 cooks in each mansion. Such is the way of mankind but global interconnectedness is very likely to raise tensions to the point of civil unrest and hot war as citizenships globally learn the truth bit by bit.


> And so whoever also will respond clearly to the other issue of the
> 78 trillion "shortfall" (or deep hole) for Citi and B of A will -at
> the very least- deserve the co-pilot seat on the spaceship I personally
> will be piloting to Mars with the rest of the World aboard.
>

Feb 11 12:41 PM

[max12345:]

Hello James C. R. (i ThinkBig)....thank you very much for definitely thinking big and for your related reply above. Which means I can now confidently look forward to your co-piloting my spaceship to Mars; But I really do hope we won't hit any geese on take off, nor have to land in the Hudson -or the Amazon, Nile, Danube, Ganges or Yangtze-

In any such eventuality -and to avoid having our collective goose fully cooked- I will have to rely on you. Personally I am not feeling very brave right at this moment given not only the high density of extremely strange large birds flying over Wall Street (and appearing before Congress) but also based on the kind of emergency crews handling forced crash landings in D.C. (and of course also well beyond and throughout our happily globalized world.... chock full of nuts of "systemic risks" all over the place)

Feb 12 04:15 AM

[Shiftless:]

The lie of bank nationalization is simply that, a lie. The powers that be, i.e. hedge funds, are essentially trying to cause banks to fail by spreading rumors that banks will be nationalized. They are trying to continue their old habits that nearly destroyed the financial system this past fall. When will the SEC wake-up and reinstate the uptick rule and ban the crack cocaine that is the SKF? The vulture hedge funds are making money on rumor and lies.

Feb 19 03:55 PM