Greenspan Joins The Politburo

Mr. Andrea Mitchell sheds his inner John Galt and comes out for nationalization.

The US government may have to nationalise some banks on a temporary basis to fix the financial system and restore the flow of credit, Alan Greenspan, the former Federal Reserve chairman, has told the Financial Times.

In an interview, Mr Greenspan, who for decades was regarded as the high priest of laisser-faire capitalism, said nationalisation could be the least bad option left for policymakers.

”It may be necessary to temporarily nationalise some banks in order to facilitate a swift and orderly restructuring,” he said. “I understand that once in a hundred years this is what you do.”

Of course, Greenspan wants to protect the senior bondholders, raising the usual spectre of total chaos. But this is a step in the right direction. And it gives the Obama Administration political cover to rip the band-aid off and do what's necessary. They'll still be tarred as socialists, but the cognitive dissonance would be too great to ignore.

I am worried that the bondholders have a gun to the head of the global economy. I don't know how you properly structure nationalization with them remaining intact - you'd just be paying them off with taxpayer money. Maybe this is why the "stress tests" to determine solvency or insolvency aren't adequate:

Via e-mail, he has confirmed our suspicions about the bank stress tests announced by Treasury Secretary Timothy Geithner: they simply cannot be adequate, given the number and experience of the staff, and perhaps as important, their relationship with the banks [...]

Now this begs the question: why has the Treasury Secretary set in motion an obviously bogus process? It suggests the result is pre-ordained.

One possibility is that even a very quick and dirty look at many of the big banks' books will reveal them to be in very bad shape. In fact, the inadequate staffing could be part of the private conversation: "You know we didn't send in enough bodies to do this right, and even using your numbers, which we can assume in some cases will be flattering, you look like a goner."

But all of Geithner's actions to date are inconsistent with him taking a tough stand. Having a lot of people party to a process that finds that some of the big banks are in trouble would be hard to keep secret (to my knowledge, none of these people have high level security clearances. Government employees and contractors in those cohorts do keep their mouths shut). So I think it is more likely that the banks will get scorecards that show them to be in various stages of peril, but none will be found to be terminal. (They can't be given a clean bill of health, that would call the whole rationale of the TARP and its various injections into question, and also would put Geithner at considerable risk if any bank declared OK fell over in less than 12 months).

But even the designation of "sick but not ready to be hospitalized" carries with it risk to the Administration. If the banks get sicker than anticipated, how can they explain it? They can't say, "oh, things got worse than we contemplated". The whole point of a stress test is to anticipate worst case scenarios. And it is pretty certain a fair number of the big banks will be on such large-scale life support by year end that it will be hard to make a case not to put them in receivership.

Whatever statement Geithner puts out about the results of the stress test is likely to come back to haunt him, as did Colin Powell's "there are WMD in Iraq" speech before the UN did. And Powell had a better reputation going into Iraq than Geithner has in prosecuting his war.

If you're not willing to legitimately analyze the banks, and the ratings agencies, for that matter, you're not going to reach the right conclusions.