The Mystery Of The Banking Solution

President Obama was deliberately vague on the subject of how to deal with insolvent banks - I believe the phrase used was that he would "make the necessary adjustments." It's probably a good idea until he determines how to best sell temporary nationalization, which looks to be a question of words:

With all eyes on the possibility of increased U.S. government ownership of embattled bank Citibank, and with increased discussion of the need for a government takeover of other major banks, a new USA Today/Gallup poll indicates that Americans' reactions to these prospects vary significantly, depending on how the process is described to them. A majority of Americans (54%) favor a temporary government "takeover" of major U.S. banks, but a much lower minority (37%) favor a temporary "nationalization" of the banks.

There's probably another phrase (pre-privatization?) that works even better. And anyway, because of the customary panic of the markets, this is an issue where you have to hold your cards right up until the moment you make the decision, and then you work quickly. The WaPo seems to think that the Administration has cleared the way for a temporary takeover (hey, I read the polls, I know what words to use), and yet the ability for the government to purchase common stock in the banks doesn't really make a lot of sense.

What we want to do is clean up the bank’s balance sheet, so that it no longer has to be a ward of the state. When the FDIC confronts a bank like this, it seizes the thing, cleans out the stockholders, pays off some of the debt, and reprivatizes.

What Treasury now seems to be proposing is converting some of the green equity to blue equity — converting preferred to common. It’s true that preferred stock has some debt-like qualities — there are required dividend payments, etc.. But does anyone think that the reason banks are crippled is that they are tied down by their obligations to preferred stockholders, as opposed to having too much plain vanilla debt?

I just don’t get it. And my sinking feeling that the administration plan is to rearrange the deck chairs and hope the iceberg melts just keeps getting stronger.

In fact, the move only makes sense if it's a prelude to temporary takeover. Perhaps the stress tests will make that clear, but those are shrouded in mystery as well (which is probably also as it should be, as a transparent process could cause runs on the banks if they are found to be struggling). Some say the vagaries of the process is causing market uncertainty, but a specific process could be even worse.

Whatever the case, the Administration needs to make its move fast. The banks are dying, and may not be able to hold out without a plan that everyone can understand and accept.