Why Bank Nationalization Will Never Happen

Includes: BAC, C, GS, JPM, MS
by: Stockton Sage
Mr. Roubini, Bank Nationalization Will Never Happen.

From sea to shining sea, the chorus is ringing out. "Wipe out the bank equity holders and bondholders, nationalize the banks, clean them up, and sell them back to private equity". The movement is so vehement now that you would think that BAC has 3 shareholders, The Guy from the Monopoly Game, the Planters Peanuts eye-piece logo guy, and Ebenezer Scrooge. I am guessing that all of the pundits that are calling for this mass carnage don't own equity or bonds in the questionable banks, but who does?

At the macro level, who usually owns bank equity and bank bonds? Well, they are usually very conservative investments, provide a steady stream of income through predictable and stable dividends and their bonds are extremely safe and pay consistently. The perfect holder of a bank stock, preferred, or bond from about 1950 to 2006 would be a retired person, a pension fund, or even 401k type plans. So why should we wipe them out?

Did you know that some of the largest holders of preferred bank stocks are other banks? That is how many banks and people create cash flow and income. If you wipe out the preferred stock of BAC and C, you would cause a domino effect in a number of other banks. Cash flow would be impeded, capital would be required to meet current needs, and government assistance would have to step in at some point. Could there be a run on the banks if you wiped out BAC and C equity and bondholders? If the bondholders are other banks that rely on those funds for operations then yes, you could see scary headlines.

Second, the baby boomers are the world's largest retirement class in history, how many of these people directly or indirectly hold bank stocks and bonds as part of their retirement? I am guessing that since up until 24 months ago they have worked like clockwork to generate income and pay dividends, that a lot of people who require income from sources other than a job, may be holding these positions. With the viability of social security already being questioned as the baby boomers age, do we really want to knock out another leg of what was once considered a very safe retirement strategy?

Third, the domino effect of killing the preferred shares and bonds will create a Lehman (OTC:LEHMQ) type ripple across the globe. Just what we need now, right? Also, I am sure that the Obama Administration has broadband internet by now, and if nationalizing the banks was going to happen, I think they would have moved on that path before the Stimulus package was passed. Obviously someone looked at the bank nationalization plan, fed it through the super-computers like Constellation at UBS, and said "WOW! I guess we better not go down that route!"

Fourth, never bet against Jamie Dimon. The guy is good - "Hall of Fame" good. When he tells me JP Morgan (NYSE:JPM) is doing fine and bank nationalization is never going to happen, I want to believe him. GS and MS want to pay TARP money back yesterday because they could be crushing it in the market right now. Ken Lewis is buying millions of dollars of BAC stock with his own money. I don't think he would be doing that if nationalization was right around the corner.

Okay, so how does this all play out? It is pretty simple really, although the timing of it is where people will be caught off guard. All the banks will be bailed out by world wide taxpayers. Each government will take on their trillions of dollars or Euros of debt, and the banks will be allowed to function. Each government will then run a deficit and take time to pay it off. Since this will end up being a "zero sum" game, with everyone taking on massive debt, the US will still be the best of breed out there. The dollar will still be a safe haven compared to the risk of other countries' currencies. The US will be the first out of the recovery gate. Decoupling is a myth and the rest of the world has to take the nosedive first, and then feed off the US recovery. Did you see that European banks were FAR MORE leveraged than US banks? They have an estimated $25 trillion USD to work through, while the US has about $7 trillion? Anyone want to go long the Euro?

The gold play is a fool's errand at this point. We are stuck in a massive deflationary cycle. Do you see Warren Buffett touting gold? Nope. He is buying corporate debt like a wild man at this point. He isn't playing the "guess the equity price" game; he is playing the "I bet these guys will still be in existence in 3 years" game. Granted, he is getting a juicy yield for biding his time and having more money than God, but still, look at what people are doing, not what they are saying. In the past few months he has bought debt in Tiffany and Co. (NYSE:TIF) (10% yield), Goldman Sachs preferred with 10% yield, and high yielding debt in General Electric (NYSE:GE), Swiss Reinsurance (OTC:SWCEY), and Harley Davidson (NYSE:HOG). His yield and bonds will do well in a deflationary time, and he has the kicker to convert to stock in all his deals.

In conclusion, look at what people are doing, not what they are saying. There will never be a bank nationalization of BAC or C in the US. The government couldn't afford the fallout of such a move. It will create a bad bank, aggregate bank, IOU bank, taxpayer bank, whatever you want to call it, and help the banks survive. Once pricing of toxic assets stabilize, even at extremely low levels, we will all know what "stuff" is worth and be able to sell and buy it again. If you read your weekend edition of the WSJ, you might have noticed that distressed debt buyers are stepping up and buying toxic assets from pension funds and banks for a few pennies on the dollar. Not a great price for selling, but still a price, and from there, more and more toxic debt can be priced out to normal buyers of debt. The recovery in the bond and debt markets has begun. Look at the debt issuance of BBB rated and above companies recently. Look at LIBOR. Look at distressed debt buyers starting to buy toxic assets, although it is at very low prices. These things would not be happening if bank nationalization was right around the corner.

Disclosure: Bond holder of JPM, MS, GS