The Nationalization Argument

In my earlier post I mentioned in passing that Obama offered a full response to critics on the left who think the banks have leveraged their power to prevent the necessary solutions to the financial crisis, like nationalization. Here it is:

On the other hand, there have been some who don’t dispute that we need to shore up the banking system, but suggest that we have been too timid in how we go about it. They say that the federal government should have already preemptively stepped in and taken over major financial institutions the way that the FDIC currently intervenes in smaller banks, and that our failure to do so is yet another example of Washington coddling Wall Street. So let me be clear – the reason we have not taken this step has nothing to do with any ideological or political judgment we’ve made about government involvement in banks, and it’s certainly not because of any concern we have for the management and shareholders whose actions have helped cause this mess.

Rather, it is because we believe that preemptive government takeovers are likely to end up costing taxpayers even more in the end, and because it is more likely to undermine than to create confidence. Governments should practice the same principle as doctors: first do no harm. So rest assured – we will do whatever is necessary to get credit flowing again, but we will do so in ways that minimize risks to taxpayers and to the broader economy. To that end, in addition to the program to provide capital to the banks, we have launched a plan that will pair government resources with private investment in order to clear away the old loans and securities – the so-called toxic assets – that are also preventing our banks from lending money.

Greg Sargent reads the tea leaves and thinks that Obama substantively responded by saying he wasn't ideologically opposed to nationalization. I think that's less important that his substantive disagreement, which is that nationalization would be more costly. Which is largely true - we saw in the IndyMac receivership that the cost totals were much larger than expected, and as Yglesias notes, nationalization would require up front money that Congress would be highly unlikely to appropriate. However, there's a bit of a false frame here. Lining up the PPIP against nationalization and saying that the PPIP is cheaper only makes sense if you think both have an equal potential of working. If, as I do, you think that the PPIP probably won't work, and that the problem is not one of liquidity but insolvency, then getting to nationalization quickly before throwing hundreds of billions more down a rathole would be significantly cheaper.

And evidence on my side of things, that the banks are insolvent, can be seen in the silly games some of them are playing to try and look profitable.

Goldman Sachs reported a profit of $1.8 billion in the first quarter, and plans to sell $5 billion in stock and get out of the government’s clutches, if it can.

How did it do that? One way was to hide a lot of losses in not-so-plain sight.

Goldman’s 2008 fiscal year ended Nov. 30. This year the company is switching to a calendar year. The leaves December as an orphan month, one that will be largely ignored. In Goldman’s earnings statement, and in most of the news reports, the quarter ended March 31 is compared to the quarter last year that ended in February.

The orphan month featured — surprise — lots of write-offs. The pretax loss was $1.3 billion, and the after-tax loss was $780 million.

Ingenious - dump all the write-downs into a missing month. Barry Ritholtz and James Kwak have more.

But when you scratch the surface of all this, you can plainly see that even the banks announcing record profits are hopelessly insolvent, and will continue to spiral downward as the economy remains stuck.

Wells Fargo & Co., the second- biggest U.S. home lender, may need $50 billion to pay back the federal government and cover loan losses as the economic slump deepens, according to KBW Inc.’s Frederick Cannon.

KBW expects $120 billion of “stress” losses at Wells Fargo, assuming the recession continues through the first quarter of 2010 and unemployment reaches 12 percent, Cannon wrote today in a report. The San Francisco-based bank may need to raise $25 billion on top of the $25 billion it owes the U.S. Treasury for the industry bailout plan, he wrote.

First-quarter net income rose 50 percent to about $3 billion, Wells Fargo said last week in announcing preliminary results that topped the most optimistic Wall Street estimates and sparked a 32 percent jump in the stock. The bank attributed the profit to a surge in mortgage originations and revenue from Wachovia Corp., acquired in December. Full results are scheduled for April 22.

The $120 billion in "stress losses" kind of puts that whole $3 billion quarterly profit in perspective, don't it?

So while I agree that nationalization would be more expensive on a one-to-one basis, and I don't even totally fault Obama for, given the institutional constraints, giving some separate option the old college try, the inevitability of dealing with the insolvent banks argues for a quick remedy.