Just Nationalize Already

Some truthsaying from the New York Times:

Some of the nation’s large banks, according to economists and other finance experts, are like dead men walking.

A sober assessment of the growing mountain of losses from bad bets, measured in today’s marketplace, would overwhelm the value of the banks’ assets, they say. The banks, in their view, are insolvent.

None of the experts’ research focuses on individual banks, and there are certainly exceptions among the 50 largest banks in the country. Nor do consumers and businesses need to fret about their deposits, which are federally insured. And even banks that might technically be insolvent can continue operating for a long time, and could recover their financial health when the economy improves.

But without a cure for the problem of bad assets, the credit crisis that is dragging down the economy will linger, as banks cannot resume the ample lending needed to restart the wheels of commerce. The answer, say the economists and experts, is a larger, more direct government role than in the Treasury Department’s plan outlined this week.

It's really time to stop calling this a doomsday prediction. The banks have been allowed to hide from reality for too long, and there are very real costs to cleaning up their mess later rather than immediately. Costs that could register in the trillions. Noriel Roubini and Matthew Richardson offer the prescription.

As free-market economists teaching at a business school in the heart of the world's financial capital, we feel downright blasphemous proposing an all-out government takeover of the banking system. But the U.S. financial system has reached such a dangerous tipping point that little choice remains. And while Treasury Secretary Timothy Geithner's recent plan to save it has many of the right elements, it's basically too late [...]

Two important parts of Geithner's plan are 1) "stress testing" banks by poring over their books to separate viable institutions from bankrupt ones and 2) establishing an investment fund with private and public money to purchase bad assets. These are necessary steps toward a healthy financial sector.

But unfortunately, the plan won't solve our financial woes, because it assumes that the system is solvent. If implemented fairly for current taxpayers (i.e., no more freebies in the form of underpriced equity, preferred shares, loan guarantees or insurance on assets), it will just confirm how bad things really are.

Nationalization is the only option that would permit us to solve the problem of toxic assets in an orderly fashion and allow lending finally to resume. Of course, the economy would still stink, but the death spiral we are in would stop.

I think everyone sees Geithner's "stress test" as helpful in determining which banks are solvent and which aren't. But right after those tests are completed, the insolvent institutions have to be nationalized with the equity-holders wiped out. The assets can be sold off to private capitalists, with depositors and debt-holders getting the proceeds. And then we start over.

The eventual outcome would be a healthy financial system with many new banks capitalized by good assets. Insolvent, too-big-to-fail banks would be broken up into smaller pieces less likely to threaten the whole financial system. Regulatory reforms also would be instituted to reduce the chances of costly future crises.

Nationalizing banks is not without precedent. In 1992, the Swedish government took over its insolvent banks, cleaned them up and reprivatized them. Obviously, the Swedish banking system was much smaller than the U.S. system. Moreover, some of the current U.S. financial institutions are much larger and more complex, making analysis difficult. And today's global capital markets make gaming the system easier than in 1992. But we believe that, if applied correctly, the Swedish solution will work here.

Arianna Huffington has more.

The one thing holding the policymakers back is an over-reliance on elites who wouldn't want to see the system fail. Already they're being threatened into overpaying for bad assets, or chaos will ensue, as if it hasn't already. This is from an economist at Deutsche Bank:

One main stumbling block to the purchasing of troubled assets has been pricing, specifically how does the government price a diverse set of assets in a way that does not put the taxpayer on the hook. However, this should not be the standard by which we judge the efficacy of the plan, because a more prolonged deterioration in the
economy will result in a higher terminal unemployment rate and a greater deterioration of the tax base. As such, the decline in tax revenues will crimp many of the essential services provided by the government. Ultimately, the taxpayer will pay one way or another, either through greatly diminished job prospects and/or significantly higher taxes down the line to pay for the massive debt issuance required to fund current and prospective fiscal spending initiatives.

We think the government should do the following: estimate the highest price it can pay for the various toxic assets residing on financial institution balance sheets which would still return the principal to taxpayers.

We shouldn't negotiate with terrorists.