At lot has happened since I last posted an article on this subject (Max Holmes Proposal). The government has moved to nearly 40% ownership of Citi Group (C). In the past week, both Citi Group and JPMorgan Chase (JPM) have announced that so far this year they are profitable (Economy). Of course we should not assume that can not be changed with further (negative) changes in the housing market or other economic activity factors. All financial institutions are extremely susceptible to suffering balance sheet pain if additional asset write-downs are necessary. Of course, write-downs will be made under applicable accounting rules and there is a lot of speculation this weekend about whether or not these will be modified. See the Seeking Alpha Market Currents news item:
Friday, March 13, 2009 4:58 PM: The U.S. Financial Accounting Standards Board (FASB) will discuss mark-to-market guidelines at a board meeting Monday. The FASB says it will focus on "additional application guidance that would clarify how mark to market is used in illiquid markets." Earlier today, FASB chairman Robert Herz told a House subcommittee that new rules could be implemented within three weeks.
An article (Friday, March 13) by Balance Sheet Future argued that mark-to-market accounting rules would not be suspended but that some modifications to improve accounting transparency would be in order.
Mark Sunshine and Louis Basenese have articles this weekend supporting suspension of FASB157 (the mark-to-market accounting rule). These articles are good reads, as is the sometime vitriolic dissension in the two comments streams. An over-simplified net of the dissenting view is that FASB157 is not the cause of the problem, but is a symptom resulting from the problem of assets declining in value.
Recently James Kwak (Nationalization) discussed five variations on bank nationalization. He came to the conclusion that whatever aspect or variety of bank/government interaction is effected, they all have a common factor:
The government is the only source of capital for the banking system; it guarantees a large proportion of bank liabilities, including virtually all deposits and new bank debt; it implicitly guarantees all large banks under the Too Big To Fail doctrine; it ensures the liquidity that keeps the system afloat, both by providing cheap money and by lending against illiquid assets; and it has stepped up buying of various securities on secondary markets in order to encourage lending. In short, the government is where the money comes from, and the government decides on a high level where it goes, through capital injections, loans, and securities purchases. And the government bears the vast majority of the risk.
Simon Johnson posted two excellent articles on March 13 about some current activities on the financial crisis. In one article he discusses current G20 discussions on the crisis (Reining In the Banks) and in the other a speech this past week by JPMorgan Chase (JPM), CEO Jamie Dimon (Business as Usual). In the first article Simon wrote:
“We need to break or substantially reduce the political power of the banks in the U.S. and in all other countries where this is a pressing first-order issue.”
The “this” he refers too was defined as:
“The only way forward is to dramatically change the effectiveness of regulation in the U.S. But this will not happen primarily through tweaking de jure rules or attempting to create one regulator with responsibility for the whole system - whether or not this is the Federal Reserve. Again, the banks have too much power - they will capture, influence, or arbitrage their way around any regulatory structures so that the next bubble, whenever and wherever it appears, will be at least as damaging as the last.”
A number of Seeking Alpha articles have discussed problems with various nationalization options, including Michael Krause, who discussed the complex counter-party dependencies between banks (among themselves) and other financial institutions; Markham Lee, who discussed the political hazards of nationalization; and James Baker, who argued that time could resolve most supposed insolvency problems. The Baker article can be reflected back upon the more recent discussion of whether or not mark-to-market accounting rules should be changed. (See discussion earlier in this article.)
Rick Newman has suggested that troubled banks like Citi Group (C) and financial giants like American Insurance Group (AIG) can be broken up slowly over time under government guidance (The Future of Citigroup and AIG).
All this brings me to a topic that was mentioned by Simon and Rick, but is not as widely discussed as perhaps it should be. That topic is: “Too Big To Fail.” I believe that as we move into an era of increased regulation, we must include limits on size of individual institutions so that "too big too fail" is not allowed to occur. This seems, at first blush, to be "anti-capitalistic", but is the socialism we now see for the rich and powerful "pro-capitalistic"?
The new financial system that emerges from this debacle must have sufficient regulation to assure that financial institutions will succeed or fail on their own merits without government support being needed. We must avoid allowing banks (or others) to manipulate their way into positions with too much power over the survival of our society. We need corporations that can go under, whether through their own stupidity or circumstances beyond their control, without sweeping the rest of the country along with them.
There has been a lot of talk about bank nationalization. Let me ask one question: What is bank nationalization: Is it the nation taking over the banks or the banks taking over the nation?
My hope is that the two choices stated in this question are not the only choices available.
Disclosure: I currently hold no positions, long or short, in any banks, financial institutions or related ETFs and mutual funds.
