Why Zombie Banks Won't Be Nationalized 25 comments
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In the view of many - including myself - nationalization of the big zombie banks in the U.S. would be the quickest and most straightforward approach to getting financial markets moving again.
The arguments against - "it's complex", "shareholders would get spooked", "it might be unfair" - sound like special pleading or an invitation to paralysis by analysis.
But there is a simple reason why nationalization won't happen except as an extreme last resort. The U.S. government's hands are tied by foreign investors.
I've written previously about China's observable influence on U.S. fiscal and monetary policy. I haven’t seen China's holdings of Citigroup (C) publicized, but they’ll be big. And there are others. Here is an extract from Sunday’s Reuters:
"Abu Dhabi is assessing its $7.5 billion investment in Citigroup as the bank's problems deepen and consequences of a possible nationalisation become clearer, according to sources close to the Abu Dhabi Investment Authority (ADIA).
ADIA invested $7.5 billon last year in Citi through convertible bonds that pay 11 percent in interest, but it must start converting the bonds into 235.6 million shares in Citigroup from March next year.
ADIA's returns as a bondholder have been unaffected by continuing troubles at Citigroup, but the dramatic fall in Citi's share price has eroded the conversion value of the mandatory convertible bonds."
Saudi Arabia is also a big holder of such bonds.
Repeat the story of exposure to all the big U.S. banks through shares or convertible bonds across the other big sovereign wealth funds (Dubai, Qatar, Singapore). The result is a lot of powerful overseas investors with strong interest in the banks not being nationalized.
Whilst they would certainly suffer from a U.S. collapse, it would be naïve not to realize they can squeeze the U.S. government by holding back on future bond purchases and thus forcing domestic interest rates up. A dangerous game for all concerned, but the U.S. has to buy time from these overseas interests as a consequence of its growing debt. Hence, no bank nationalizations.
To put it simply, through bad management, the U.S. has substantially foregone the ability to manage its economy in the interests of its own citizens.
Disclosure: no positions
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As the article says:
"Whilst they would certainly suffer from a U.S. collapse, it would be naïve not to realize they can squeeze the U.S. government by holding back on future bond purchases and thus forcing domestic interest rates up."
On Mar 02 09:15 AM pacman1947 wrote:
> Whoa, Nelly! You mean American taxpayers must bail out these zombies
> because oil-rich sheiks own shares? Huh?
>
> I hope there's more to it than that.
This is actually nonsense, as these people know as well as you do that there investment is wiped out already, and that the taxpayer is not going to pick up more than they absolutely have to.
The bottom line is the Treasury has limited room for manoeuvre as they cannot afford to destablise the dollar. Everyone already knows the dollar is likely to collapse. Unfettered and gratuitous expansion of the balance sheet over and above what is already committed can only make the prospect of dollar collapse more imminent.
The US needs to bring down the dollar. I am sure even Bernanke is not daft enough not to be able to see that, but it needs to be done in a controlled way and not another mad scramble for the exit. However, one would have to rate their chances of success between slim and non-existent.
And what exactly could they do? "...squeeze the U.S. government by holding back on future bond purchases and thus forcing domestic interest rates up"???
OK, perhaps Saudi Arabia, Dubai, and China will only accept payment in physial paper currency and build Scrooge McDuck money bins for their export proceeds, rather than buying US investments. Maybe they're fine with losing HUNDREDS OF BILLIONS of dollars in purchasing power to inflation each year, just because they want to teach the US a lesson for nationalizing the broke banks and costing them a few billion! That'll teach em! Yea!
Thanks for a good laugh, but that's just not how the world works.
The US has been "nationalizing" banks for 70 years through the FDIC. The value of the stocks and bonds of bankrupt banks, similarly, have been going to zero for much longer than that. Investors sometimes lose, and foreign investors are sophisticated enough to understand that, I assure you. I don't think we'll see any coordinated hissy fits from billionaire money managers who didn't know the risks they were taking.
Treasury rates will likely rise, but that will be because foreign investors have fewer dollars to invest because of falling exports, not because they want revenge or something. US buyers are increasingly picking up the slack.
On Mar 02 08:52 AM Ranchr wrote:
> Bring back Up-Tick; stop naked shorting of banks; suspend mark-to-market
> and this will all work itself out.
The 500 Trillion oTC derivatives market (interest, currency and credit swaps) means a degree of inter-connection that creates one super-bank and not 15-20 individual companies.
seize one and they all must be taken, internationally as well.
Since the government can't actually run these huge institutions any better, there is really no point nationalizing anything until the derivatives portfolios are unwound. By the time that occurs the institutions will either be able to get back on their feet or not.
Many of these derivatives operate on a 1-5 year schedule. The longer the government can keep the institution up, the more derivatives basically just time-out. That combined with new regulation on CDS ownership will eventually unwind the mess enough to allow AIG to go into bankruptcy, probably Citi too, and possibly others later on, without creating a chain reaction.
Of the large banks BofA has a fairly good shot at being able to recover. Citi is really the only large bank which is effectively dead. The others, including BofA, but most particularly Wells Fargo, actually have very good cash flows. Wells added over 8 billion to their loan loss provision in Q4 alone, for example.
So for the large banks it winds up being a race between the ability to build the loan loss provision and the default rate from the mortgage portfolio. Actual losses from the mortgage portfolio are determined by Home prices. They don't have to recover per-say, they simply have to stabilize and banks like Wells will very quickly shift back into profit mode.
BofA can pull this off too but BofA has a 30+ trillion dollar derivatives portfolio to deal with (Citi's is even larger, and AIG's is the largest of all!). BofA has a fairly large exposure to loss there. Wells Fargo has only 11 billion or so in liabilities on the 'tiny' (tiny == 'only' 4 trillion) derivatives portfolio it inherited from Wachovia, and 30 billion in assets. BofA's exposure is in the 50 billion+ range. AIG's is in the 300 billion+ range. From looking at Wells' 10-K, Wells seems to have done a good job with netting arrangements. For Wells the derivatives portfolio inherited from Wachovia seems to be more of an annoyance then anything else.
I think the government should open up AIGs books. We have a right to know exactly what derivatives are in there. A lot of the cash the government is throwing at AIG is collateral for those derivatives, basically being handed over to AIG's counterparties for escrow. I want to know where it is going.
-Matt
The author has his leverage backwards. Sovereign Wealth Fund investments in Citigroup need the US government or they're toast, not the other way around.
On Mar 02 09:15 AM pacman1947 wrote:
> Whoa, Nelly! You mean American taxpayers must bail out these zombies
> because oil-rich sheiks own shares? Huh?
>
> I hope there's more to it than that.
@GreenEyes,
"Nationalization" of the money center banks is NOT "socialism"!!!! Please understand that they are members of the Federal Deposit Insurance Corporation -- now THAT has elements of socialism, certainly -- and are therefore subject to conservatorship and restructuring as a part of membership. The "socialism" happened in the mid-30's when the FDIC was established. It's been used before on a large money center bank, Continental Illinois, without dashing the US into the maw of rapacious Socialism. (key dark music). There is no sudden "slippery slope" and it happens all the time to smaller institutions that get into trouble.
However, one problem is that the nominal assets and liabilities of the big five are so huge that the cost may be several trillion dollars. But also, once insolvency is invoked it becomes the FDIC's (or more likely another agency like the S&L Resolution Trust Corporation) responsibility to make decisions about "haircuts" for various holders of the failed institution's liabilities.
Since so many of those liabilities are held by foreign sovereign and near-sovereign investors -- especially those of Citigroup -- taking the step of declaring insolvency and embarking on the impossible to get completely fair and just process of assigning those haircuts is fraught with serious international relationship minefields. So the government is doing exactly what most other people and institutions do when faced with an unpleasant task: equivocating.
Since there is the possibility that aggrieved foreign investors might tank US markets much more severely than they have so far, equivocation has some genuine attractions. Things MIGHT turn up.
On Mar 02 10:50 AM Green Eyes wrote:
> I don't think that moving our country one step closer to socialism
> (nationalization) is the answer...
You don't "Short For Me" you illiterate moron. Before you go slinging around epithets, LEARN HOW TO SPELL THEM! It's "Bolshevik". And what the hell is "emergently"? Is that a new adjective sourced from "emerging markets"? And if so, are you expecting to sell the the bogus paper your friends of Wall Street created to Rwanda and Bolivia?
And finally, I guess Democrats in the House and Senate will be unbolting their chairs from the desks and urging them to run out the door to attack their constituents? One does not "loose" one's seat in Congress. One "loses" it.
P.S.
You need a do-over in third grade to learn spelling. Apparently you have not noticed that this website puts a red line under any series of characters separated by a space or punctuation mark that it does not recognize as a word. There's one under your alias; there's one under mine. Because they're not WORDS! You might take notice of those red lines when you are typing your post. When one appears it's a hint that what you just typed doesn't make sense!
On Mar 02 01:25 PM Ishortyou wrote:
> well Iooks like the 'stress test' theory from the socialist bolchevics
> democrats is not working that well, already wiping out the retirement
> plans of pop and mom. Looks like cleaning the balance sheet of banks
> from those 'securitized bonds' i.e. MBS, CDO is a viable alternative
> that needs to be implemented emergently, but with the socialists
> bolchevics democrats worried about loosing their seats from the blackmailers
> constituents vote outs, are probably not going to do it, so sit tight
> and expect a major diving for several years to come.
I don't care if the banks are kept in private hands, what I want is for the present management to be discharged and the balance sheet cleaned up so that if can properly function once again. The notion that the very individuals that thought housing prices can only go up and that securitization and leverage could be done with limited risk shows their collective incompetence. Let us rebuild the banks with new management for the new business model they will operate under. And spare me the sermon on how detrimental regulation and oversight is to businesses. I'll take a side of that as well.
1) Nationalization is bad. Normally yes. But if taxpayers are going to fund massively costly bank rescues, they should be first in the queue for any returns and existing shareholders should lose. That means the government on the taxpayers' behalf gets the equity stake = nationalization. Once (if!) revived, the banks can be put back on the market.
2) Foreigners got no choice but to buy U.S. paper. There are strong inter-dependencies but that doesn't mean the U.S. is in control. If foreign interests had to buy whatever debt the U.S. issued, why should anybody in the U.S. bother to work at all. Just put it on the tab. The question is how close are we to the limits of that tab, and what sort of games are being played.
3) The losses on U.S. banks are too small to worry about and these sovereign funds have lost it all anyway. No and no. With trillions being tossed around, don't imagine that the loss of $10s of billions to a sovereign fund is minor. Hey, they could bail out GM with that. And whilst the bank shares remain valid, the game isn't over and there's a chance they'll go up. As the manager of a mega sovereign fund, you'd rather avoid admitting an absolute loss on a big slab of your portfolio. E.g. Singapore's Temasek fund recently admitted to losses of some US$30 billion. Even in tightly controlled Singapore, the government delayed that announcement and was palpably nervous.