"Nationalization" now in the mainstream press

January 26, 2009
News Analysis
Nationalization Gets a New, Serious Look
By DAVID E. SANGER

WASHINGTON — Only five days into the Obama presidency, members of the new administration and Democratic leaders in Congress are already dancing around one of the most politically delicate questions about the financial bailout: Is the president prepared to nationalize a huge swath of the nation’s banking system?

Privately, most members of the Obama economic team concede that the rapid deterioration of the country’s biggest banks, notably Bank of America and Citigroup, is bound to require far larger investments of taxpayer money, atop the more than $300 billion of taxpayer money already poured into those two financial institutions and hundreds of others.

But if hundreds of billions of dollars of new investment is needed to shore up those banks, and perhaps their competitors, what do taxpayers get in return? And how do the risks escalate as government’s role expands from a few bailouts to control over a vast portion of the financial sector of the world’s largest economy?

The Obama administration is making only glancing references to those questions. In an interview Sunday on “This Week” on ABC, the House speaker, Nancy Pelosi, alluded to internal debate when she was asked whether nationalization, or partial nationalization, of the largest banks was a good idea.

“Well, whatever you want to call it,” said Ms. Pelosi, Democrat of California. “If we are strengthening them, then the American people should get some of the upside of that strengthening. Some people call that nationalization.

“I’m not talking about total ownership,” she quickly cautioned — stopping herself by posing a question: “Would we have ever thought we would see the day when we’d be using that terminology? ‘Nationalization of the banks?’ ”

So far, President Obama’s top aides have steered clear of the word entirely, and they are still actively discussing other alternatives, including creating a “bad bank” that would nationalize the worst nonperforming loans by taking them off the hands of financial institutions without actually taking ownership of the banks. Others talk of de facto nationalization, in which the government owns a sizeable chunk of the banks but not a majority, with all that connotes.

That has already happened; taxpayers are now the biggest shareholders in Bank of America, with about 6 percent of the stock, and in Citigroup, with 7.8 percent. But the government’s influence is far larger than those numbers suggest, because it has guaranteed to absorb the losses of some of the two banks’ most toxic assets, a figure that could run into the hundreds of billions of dollars.

Many believe this form of hybrid ownership — part government, part private, with the responsibilities of ownership unclear — will not prove workable.

“The case for full nationalization is far stronger now than it was a few months ago,” said Adam S. Posen, the deputy director of the Peterson Institute for International Economics. “If you don’t own the majority, you don’t get to fire the management, to wipe out the shareholders, to declare that you are just going to take the losses and start over. It’s the mistake the Japanese made in the ’90s.”

“I would guess that sometime in the next few weeks, President Obama and Tim Geithner,” he said, referring to the nominee for Treasury secretary, “will have to come out and say, ‘It’s much worse than we thought,’ and just bite the bullet.”

So far the Obama administration has signaled that it is trying to avoid that day, and members of its economic team — among them Mr. Geithner and the president’s top economic adviser, Lawrence H. Summers — made the case during the Asian financial crisis in the 1990s that governments make lousy bank managers.

Indeed, the risks of nationalization they warned about then apply equally to the United States now. The first is that nationalization can prove contagious. If the Obama administration took over Bank of America and Citigroup, two of the largest banks in the United States, private investors could decide to flee from the likes of JPMorgan Chase and Wells Fargo, or other major banks, fearing they could be next.

Moreover, Mr. Obama’s advisers say they are acutely aware that if the government is perceived as running the banks, the administration would come under enormous political pressure to halt foreclosures or lend money to ailing projects in cities or states with powerful constituencies, which could imperil the effort to steer the banks away from the cliff.

“The nightmare scenarios are endless,” one of the administration’s senior officials said.

The argument in favor of nationalization, even a brief nationalization of a few months or years, is straightforward: It might be the only way to pull America’s largest financial institutions out of the downward spiral that makes it enormously difficult to raise the capital they need to keep operating.

Right now, many banks are reluctant to write off their bad debts, and absorb huge losses, unless they can first raise enough capital to cushion the blow. But they cannot attract that capital without first purging their balance sheets of the toxic assets. Japan’s experience proved the dangers of that downward swirl; the economy stagnated, new lending ground to a halt and the country’s diplomatic clout shrank with its balance sheets.

Nationalization could pull the banks out of that dive, at least temporarily, as the government injected capital, hired new managers and ordered a restart to lending. But some Republicans who bit their tongues when President George W. Bush ordered huge interventions in the market would charge that Mr. Obama was steering America toward socialism.

Nationalization, said Charles Geisst, a financial historian at Manhattan College “is just not a term in the American vocabulary.”

“We think of it,” he continued, “as something foreigners do to us, not something we do.”
It is also something foreigners do to themselves: the British have recently taken a majority stake in the Royal Bank of Scotland.

Some of Mr. Obama’s advisers have asked who the government would get to run the banks. Many of the most experienced executives are tainted by the decisions they made during the age of excess. And how would the government attract the best talent if it demanded that they take minimal pay — a political reality in the current environment?

Another option is for the government to buy the banks’ most toxic assets either through a giant fund, or, more likely, a federally supported bad bank designed to buy up troubled investments. But in that case, taxpayers might well be the losers: They would have all of the banks’ worst assets and none of their performing loans. And unless a deal is worked out to take a larger share of the banks whose bad loans are shuffled off to the government, the taxpayers would not have the chance to benefit by selling the shares back to private investors.

Moreover, cleaning up the banks’ bad assets, without extracting a heavy price for the bank managers, shareholders and their lenders, is exactly what Mr. Summers and Mr. Geithner warned against during the Asian financial crisis.

“We told the Asians that they had to be willing to let banks and companies fail,” said Jeffrey Garten, a professor at the Yale School of Management and a top official in the Clinton administration. “We warned that there was great moral hazard if governments just bailed them out.”

“And now,” he said, “we are doing the polar opposite of our advice.”

Eric Dash contributed reporting from New York.

I have been calling for a Nationalization since the middle of last year. It is obvious to everyone why banks have NO CAPITAL available. Where is all the private money - its on the sidelines (a lot of it is probably in Zurich) because everyone knows the king has no clothes. But here we are - hemming and hawing our way to a Global Depression because we dont have the balls to say yes we need to Nationalize these insolvent institutions. Even at this late hour - it is not too late. Declare a Bank Holiday and Nationalize these insolvent institutions. Wipe out the shareholders and their lenders. NOW. The Global Depression clock is now ticking. Tick, Tock.

Ballpark: 1-2 Trillion and counting....

from ft.com (Financial Times)

America will need a $1,000bn bail-out
ByKenneth Rogoff
Published: September 17 2008 19:06 Last updated: September 17 2008 19:06

One of the most extraordinary features of the past month is the extent to which the dollar has remained immune to a once-in-a-lifetime financial crisis. If the US were an emerging market country, its exchange rate would be plummeting and interest rates on government debt would be soaring. Instead, the dollar has actually strengthened modestly, while interest rates on three- month US Treasury Bills have now reached 54-year lows. It is almost as if the more the US messes up, the more the world loves it.

But can this extraordinary vote of confidence in the dollar last? Perhaps, but as investors step back and look at the deep wounds of America’s flagship financial sector, the public and private sector’s massive borrowing needs, and the looming uncertainty of the November presidential elections, it is hard to believe that the dollar will continue to stand its ground as the crisis continues to deepen and unfold.

It is true that the US government has very deep pockets. Privately held US government debt was under $4,400bn at the end of 2007, representing less than 32 per cent of gross domestic product. This is roughly half the debt burden carried by most European countries, and an even smaller fraction of Japan’s debt levels. It is also true that despite the increasingly tough stance of US regulators, the financial crisis has probably already added at most $200bn-$300bn to net debt, taking into account the likely losses on nationalising the mortgage giants Freddie Mac and Fannie Mae, the costs of the $29bn March bail-out of investment bank Bear Stearns, the potential fallout from the various junk collateral the Federal Reserve has taken on to its balance sheet in the last few months, and finally, Wednesday’s $85bn bail-out of the insurance giant AIG.

Were the financial crisis to end today, the costs would be painful but manageable, roughly equivalent to the cost of another year in Iraq. Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn to $2,000bn.

True, the US Treasury and the Federal Reserve have done an admirable job over the past week in forcing the private sector to bear a share of the burden. By forcing the fourth largest investment bank, Lehman Brothers, into bankruptcy and Merrill Lynch into a distressed sale to Bank of America, they helped to facilitate a badly needed consolidation in the financial services sector. However, at this juncture, there is every possibility that the credit crisis will radiate out into corporate, consumer and municipal debt. Regardless of the Fed and Treasury’s most determined efforts, the political pressures for a much larger bail-out, and pressures from the continued volatility in financial markets, are going to be irresistible.

It is hard to predict exactly how and when the mega-bail-out will evolve. At some point, we are likely to see a broadening and deepening of deposit insurance, much as the UK did in the case of Northern Rock. Probably, at some point, the government will aim to have a better established algorithm for making bridge loans and for triggering the effective liquidation of troubled firms and assets, although the task is far more difficult than was the case in the 1980s, when the Resolution Trust Corporation was formed to help clean up the saving and loan mess.

Of course, there also needs to be better regulation. It is incredible that the transparency-challenged credit default swap market was allowed to swell to a notional value of $6,200bn during 2008 even as it became obvious that any collapse of this market could lead to an even bigger mess than the fallout from subprime mortgage debt.

It may prove to be possible to fix the system for far less than $1,000bn- $2,000bn. The tough stance taken by regulators this past weekend with the investment banks Lehman and Merrill Lynch certainly helps.

Yet I fear that the American political system will ultimately drive the cost of saving the financial system well up into that higher territory.

A large expansion in debt will impose enormous fiscal costs on the US, ultimately hitting growth through a combination of higher taxes and lower spending. It will certainly make it harder for the US to maintain its military dominance, which has been one of the linchpins of the dollar.
The shrinking financial system will also undermine another central foundation of the strength of the US economy. And it is hard to see how the central bank will be able to resist a period of allowing elevated levels of inflation, as this offers a convenient way for the US to deflate the mounting cost of its private and public debts.

It is a very good thing that the rest of the world retains such confidence in America’s ability to manage its problems, otherwise the financial crisis would be far worse.

Let us hope the US political and regulatory response continues to inspire this optimism. Otherwise, sharply rising interest rates and a rapidly declining dollar could put the US in a bind that many emerging markets are all too familiar with.

The writer is professor of economics at Harvard University and former chief economist of the International Monetary Fund

Several important points are raised. First - we are going to reflate (read inflate) - read the Fed statement from a couple of days ago again. They're concerned (wink, wink) about inflation. What they're actually saying is: we'll do anything to avoid zero bound on interest rates. Anything to avoid Japan 2.0 and deflation. Second - the cost is 1 - 2 Trillion dollars. I think 1 Trillion is the LOWER bound. The ultimate costs of Nationalization, Backstopping, creating a TARP / Bad Bank whatever you call this will include costs of: Fannie and Freddie, Nationalization Insolvent Banks, AIG and the cost of TARP that Hank Paulson discussed today. It means that inflation is certain as money (debt) is created. Dollar will likely fall and Gold and Commodities will rise. Again.