As featured on p. 218 of "Bloggers on the Bus," under the name "a MyDD blogger."

Tuesday, March 10, 2009

The Great Nationalization Debate

I've been reading a whole heck of a lot the past couple days on the nationalization debate (or pre-privatization, or temporary receivership, or whatever sounds people-friendly enough for you). It started with an Alan Blinder column pushing back on the growing consensus that the banks are insolvent and need to be taken over temporarily. He thinks that it would be hard to stop the ball rolling downhill once you start nationalizing, and the short sellers would be out in force to crumble everyone in the private market, and that confidence would be undermined. And so he argued for what amounts to a taxpayer bailout.

Let’s first at least explore what is called the “good bank, bad bank” approach.

What’s that? While there are many variants, the basic idea is to break each sick institution into two. The “good bank” gets the good assets, presumably all the deposits and a share of the bank’s remaining capital. As a healthy institution, it can presumably raise fresh capital and go on its merry way as a private company.

The “bad bank” inherits the bad assets and the rest of the capital — which, after appropriate markdowns of the assets, will not be enough. So, again, someone must fill the hole. And, realistically, given the mess we’re in, much of that new capital would likely come from the taxpayers.

Yves Smith called the piece amazingly disingenuous, particularly when Blinder warned against nationalizing 8,300 banks; nobody's talking about that, and the top 5 hold 45% of all deposits. Paul Krugman doesn't understand what Alan Blinder is talking about, because he's basically arguing for massive taxpayer outlays.

You might say, why can’t a bank just split itself, giving the bad stuff to one piece and the good stuff to the other? Because it has to divvy up the liabilities as well as the assets. And if it gives the bad bank (which isn’t solvent) a bunch of the liabilities, this amounts to defaulting on its debts — and the bondholders will sue. So the good bank-bad bank thing seems to implicitly carry the assumption that someone, namely you and me in our capacity as taxpayers, guarantees the bad bank’s liabilities. In which case we are in fact nationalizing the losses, but privatizing the gains.

And yet there may be some trouble with a Swedish-style solution, and nationalization proponents shouldn't paint a completely rosy picture (not do they, for the most part - I think most are resigned to it). For one, it would also be extremely expensive. If the government takes over bank debts in a nationalization scenario, they're on the hook for over a trillion dollars, at least at the start before the upside kicks in. This is probably why Obama's team wants to bring in private money to offset the costs. Then there is the possibility of contagion, where one bank is affected by the nationalization of others, particularly because of the interconnected nature of the lending (as Kevin Drum says, this can be addressed with swift and effective action). And there's the question of how to deal with the bondholders, which is really more of a political question.

If you've got a big insolvent bank and you need to make up a big hole on the balance sheet you've got, broadly speaking, four groups of people you can get the money from, or put a different way, who can take the hit: shareholders, depositors, bondholders and taxpayers.

Now, for most of these banks the stock price has essentially fallen to zero. So they're pretty much already wiped out. Not much to be accomplished there, although those folks want to hold on to their equity in the hopes that they may recover on the upside. Then you have the depositors. But in FDIC insured accounts, they've got a federal guarantee up to $250,000. And presumably those with really big sums on deposit have been proactive enough to spread their money around several institutions. So not much luck there either.

Which leaves you with bondholders (the companies creditors rather owners) and taxpayers. Now, on the one hand, this sounds like a no-brainer. If you lend money to a company that goes bankrupt, that's tough luck. Maybe you recover a percentage on the dollar of what you were owed. But too bad. Why taxpayers should cover those loses is really hard to answer. But let's try it.

The counter-argument is that if bondholders, especially the most 'senior creditors', take a big hit it, will create a big shock to the financial system worldwide, making bond-investing money extremely risk-averse for a long time and making the credit markets seize up again on far worse a scale than happened last fall in the wake of the Lehman bankruptcy.

A second issue is that a lot of these bondholders are other financial institutions, so you create a cascade of failure.

(ed.note: as I spoke to economists who are extremely knowledgeable and I think not at all inclined to be carrying the water of the bondholders, what became clear to me is that it's not just a question of our having no good theory of how to unwind a crisis like this, 'we' also don't have a good handle on the facts of the situation, which makes everything much more perilous. Sort of like defusing the time bomb without having put the bomber on the rack long enough to have him tell you how it works. As one of them told me a few moments ago, the only people who really know where the bodies are buried are the folks who buried them. So as we're trying to come up with some global fix, the people who screwed everything up won't tell us where they put everything or what's connected to what.)

That would be a systemic risk to the greater economy, and on a more personal level it could mean the wipeout of every insurance company, every public pension fund, etc.

These are big questions, and they deserve a serious debate. Not the "let the banks fail" debate that Republicans are having with themselves, but a serious debate where the costs and benefits are weighed. Ultimately, I give a lot of weight to Simon Johnson, late of the IMF, because he's actually done this in other countries before, and knows the prescriptions, without the patina of American exceptionalism or the biases of "too big to fail," and he can actually reach a sober judgment. And he says that the normal process would be receivership. For those who don't have the time to listen at the link, Ezra Klein summarizes:

The problem in America, he says, is that the regulatory apparatus is largely made up of bankers and people who are sympathetic to bankers. "On [Geithner's] board, for example, back in the spring was Jami Dimon, head of JP Morgan. And the way, of course, in which Bear Stearns was rescued back in the spring was being sold, at what many thought was a very low price, to JP Morgan. It's a very strange world in which you can sell, over a weekend, such a valuable asset to someone who's on your board of directors, and nobody even raised an eyebrow about that."

Terry Gross goes on to ask if Johnson has ever advised a country that successfully solved a banking crisis by buying the troubled assets. "No," laughs Johnson, "I don't think anyone has ever bought troubled assets like that. It's a terrible idea, by the way. If you look at what Sweden did and talked to the people who managed their bank takeovers, they will tell you it was very hard to value the main assets held by the banks. it was real estate, and real estate always does what it's doing now. It becomes very illiquid. It's very hard to know what is the market price. That's the problem.

"But Mr. Paulson and Mr. Bernanke have presented this as 'oh my goodness, we've never seen this before, the markets have dried up, it's crazy and temporary and will only go away if we pay top dollar for these assets.' That's not true. This happens all the time in financial crises. You always get illiquidity. You always get the value of assets becoming questionable. What you do is the takeover and the nationalization and the re-privatization of banks and while you're doing that you take the really bad assets off the balance sheets and create an asset management company -- now being called a 'bad bank' -- that's a separate entity and does loss minimization. And that was done by the people who ran the Resolution Trust Company in the 80s. They did a great job, by the way."

There's actually not a lot of difference, interestingly, between Blinder's "good bank/bad bank" scenario and receivership. The main difference is that in receivership, taxpayers are cut in on the upside. And I can't see how you would then be able to do anything else. It's just, as Johnson says, a question of political will, to stare down the bankers and the wealthy equity holders. There are also the above-mentioned concerns about available funds and which banks to put into receivership that could be a cause for the current dithering. But this is a pretty robust argument being had out here in the blogosphere. Indeed, it's a core competence of the medium. And as Simon Johnson - yes, the same Simon Johnson - argues, maybe the President shouldn't be so quick to dismiss it.

In Sunday’s NYT, the President is quoted as saying (at the end of the story),

"Part of the reason we don’t spend a lot of time looking at blogs is because if you haven’t looked at it very carefully, then you may be under the impression that somehow there’s a clean answer one way or another - well, you just nationalize all the banks, or you just leave them alone and they’ll be fine."

Blogs relax previous format restrictions. Length can vary, as can technical content. Comments allow immediate feedback, clarification; debate is healthy for ideas. Experts can now express a view or an endorsement immediately to a broader audience - and get pushback, as appropriate.

And, on the President’s point, experts can now talk directly to other experts at a very detailed operational level, and the results of that conversation are now public - and again attract public content (let’s be honest: sometimes experts are way off-base and they need to be told). This is very threatening to official technocrats, both because their monopoly on expertise crumbles and because a broader set of people become skilled at criticizing their ideas. These technocrats would much rather have their boss read newspapers and weekly magazines.

I think most people are pretty clear about our options and none of them are entirely appealing. Some think we're generally screwed no matter what we do, given how much money is tied up in the derivative market. Some think taxpayers will be paying through the nose for a long time and the real action to get right is the financial re-regulation afterwards, to ensure these same clowns don't break capitalism again. Some others are just pissed that the world is going to end over something as mundane as credit default swaps and not something cool like an ape revolution. But there is a conversation, a knowledgeable one, that recognizes you can't just keep tossing money down the gaping maw of the financial system and somehow expect different results.

We need to rip off the band-aid and do it quickly. The conversation is great, the arguments and counter-arguments illuminating, but if we're screwed, we're screwed. Let's not wait on it, and let's at least have some minimal equanimity in who gets the bill at the end of the day.

While I am pretty happy with Obama in many respects, I have to give him a D for how he's handling the banks, and in particular the debate over the banks.

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