Why Isn't the Administration Backing Nationalization?

Last week, the drumbeat for bank nationalization was widespread and loud. In this instance, nationalization means wiping out shareholders and long-term debt holders, taking over operations, chopping up the companies and selling off the parts, and getting the government out of the banking business as quickly as possible. But the Obama administration seems to be against such a move… at least for now. That position puzzles many, including the President’s most strident supporters.

So why hasn’t the administration backed nationalization? Is the reason based on foreign policy? After all, don’t a lot of our allies have giant stakes in these banks via sovereign wealth funds and rich princes?

I’m just speculating here, in an atypically conspiratorial manner. But it seems kind of odd that our government is advising GM and Chrysler to prepare for bankruptcy, while allowing the money center banks to remain zombies. Personally, I don’t think it’s to protect U.S. shareholders. I think it’s to protect foreign investors. And I’m not sure that there is a conspiracy either. I think it’s fear of another domino effect.

Foreign investors via SWFs have injected billions in capital over the past year and a half only to see their investments deteriorate to pennies on the dollar. But at least those foreign investors have some hope of recovery. If you nationalize and wipe out shareholders, then that hope goes away. A message will have been sent. The U.S. is a dangerous place to invest. No safer than any other country.

With Lehman’s bankruptcy, the problem was the apparatus: Lehman defaulted on all of their debt, including money market debt. That caused the Reserve Primary Fund to break the buck. Investors suddenly realized that money market funds weren’t as safe as previously thought, so you had a run on money market funds and large bank deposits. The increase in FDIC limits and the guarantees on business checking accounts and money market funds stemmed the outflow.

With bank nationalization, you can’t rule out that such an act would be interpreted as “The Americans took our money, paid themselves lavishly, and then stiffed us. Get out of the U.S. while you can.” And with our outlandish dependence on foreign investment to support our skyrocketing debt, can we afford to send that message? I’d be worried about another ”run”, only this time it is foreigners running from all sorts of U.S. assets, including Treasury debt. Perhaps some foreign governments have called Geithner and Clinton and told them what they think about nationalization.

Moreover, part of the nationalization solution is selling off the parts. One thing you have to consider is, after seeing the U.S. wipe out prior shareholders and debt holders, who is going to have the guts to step up and buy?

Realize, I am not advocating a position here. I don’t want one penny more of my tax dollars used to prop up these institutions, their shareholders, their creditors and the executives who ran these companies into the ground. But I do want to point out that nationalization may have unintended consequences that are not being discussed by the nationalization advocates.

Comments

[venividivici:]

You are dead right, Don. That's what they fear and it's well founded.

Feb 24 06:16 AM

[Doc 224899:]

We can only hope that President Obama opposes nationalizing the banks because he doesn't want to bankrupt all the banks' shareholders (not just individuals, but also retirement funds and insurance companies), and doesn't want to completely destroy the entire banking and finance sector.

We might explain the way President Obama's most strident supporters are puzzled that he doesn't want to nationize the banks by observing that his most strident supporters aren't the brightest bulbs on the tree.

Feb 24 09:57 AM

[Mad Hedge F...:]

The Treasury moved to raise its stake in Citigroup (C) by up to 40% by converting preferred into common, yet another step down the road to creeping nationalism. With C trading as low as $1.20 on Friday, taking its market cap down to a mere $10 billion, does anyone care? The markets have already delivered their own judgment. Does this mean my ATM is going to start working with the same frustrating inefficiency of Amtrak, another poorly run government entity? The market cap for all 24 banks in the S&P 500 subsector has shrunk to $269 billion, less than the capitalization of Exxon (XOM) at $354 billion. The stock market hated all of this and fell 251 to a new 12 year low at 7,114.

Feb 24 10:51 AM