Back To Reality

The stock market provided perhaps the right punctuation to this Inauguration Day, reminding everyone that the economy won't magically repair itself because of the change in occupancy at the White House. In fact, given the deterioration in the banking sector this past week, I'd say we got off easy with just a 4% drop.

NEW YORK (AP) -- Fear that the global banking crisis is worsening sent financial stocks plunging Tuesday, with many companies' shares down by double-digit percentages and Citigroup Inc. diving to a 17-year low.

Disheartening news came from U.S. and British banks: They are still suffering losses from loans and are warning that those losses will not subside anytime soon. Regional banks as well as the big money center banks are struggling [...]

Evidence that the banking crisis is worsening overseas also rattled investors. On Monday, the Royal Bank of Scotland forecast a loss of $41.3 billion in 2008. That led the British government to increase its stake in RBS to nearly 70 percent, essentially nationalizing the bank. Separately, the British government announced a new round of bailouts for the country's troubled banking industry.

Bank stocks also dropped in the aftermath of multibillion losses announced Friday by Citigroup Inc. and Bank of America Corp.

15-20% losses were the NORM for a lot of banks today. The UK banks are getting a very generous bailout, with guarantees made against their losses in mortgage-backed securities, instead of allowing the shareholders to bear the brunt of the pain. Gordon Brown may want to clean up the balance sheets but he's really just sinking massive amounts of money into the system. Meanwhile, the US is considering building a "bad bank" where the toxic waste would all flow to, paying off banks for ridding themselves of their own self-created problems. Paul Krugman had a good piece on this yesterday; basically, we're using an artificial respirator to keep the banks alive. They are completely dependent on the government, and yet we are unwilling to do the cheaper and more sensible thing and just nationalize them.

Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, recently tried to describe how this would work: “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?

In my example, Gothamgroup is insolvent because the alleged $400 billion of toxic waste on its books is actually worth only $200 billion. The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.

Now, maybe private buyers aren’t willing to pay what toxic waste is really worth: “We don’t have really any rational pricing right now for some of these asset categories,” Ms. Bair says. But should the government be in the business of declaring that it knows better than the market what assets are worth? And is it really likely that paying “fair value,” whatever that means, would be enough to make Gotham solvent again?

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets.

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. The truth is that Gothamgroup and its sister institutions are already wards of the state, utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

There are very real consequences to this. We've already lost something like $64 billion dollars from the initial TARP release (remember when that was called an "investment" and we were all assured we would get the money back?). Everybody's tiptoeing around the solution. England owns 70% of the Royal Bank of Scotland and won't nationalize it.

Without President Obama (yay, I get to write that!) leveling with the American people, we will continue to waste more money propping up an insolvent set of banks.