The Back Alley Archives

I don't pretend to be enough of an expert, or to be close enough to the facts, or to have a large enough staff, to know what should be done with the banking system, which is at the center of our current economic turmoil. But I am confident that fixing it should be the main focus of policy efforts.

In this regard, I found this tidbit thought-provoking:

"The word 'nationalization' scares the hell out of people," Rep. Maxine Waters, D-Calif., said on "This Week." To combat that, some clever advocates of nationalization have come up with alternative names, including "government receivership" and "pre-privatization." (Source.)

The search for alternative names can be amusing at first, but I think there is more here than mere semantics.

Why are people scared about the idea of nationalization? One reason is that it is a sign of the depth of our problems. A second, more substantive reason is that it seems to point in a bad direction. I certainly do not want the government deciding who deserves credit and who does not, what kind of investments are worthy of financing and what kind are not. That is a big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.

If the government is to intervene in a big way to fix the banking system, "nationalization" is the wrong word because it suggests the wrong endgame. If banks are as insolvent as some analysts claim, then the goal should be a massive reorganization of these financial institutions. Some might call it nationalization, but more accurately it would be a type of bankruptcy procedure.

Bankruptcy could become, in effect, a massive bank recapitalization. Essentially, the equity holders are told, "Go away, you have been zeroed out." The debt holders are told, "Congratulations, you are the new equity holders." Suddenly, these financial organizations have a lot more equity capital and not a shred of debt! And all done without a penny of taxpayer money!

I am sure there are a host of legal issues here. The government cannot blithely walk into banks and tell them they are insolvent when the banks are saying (pretending? hoping? praying?) otherwise. But as bank regulators, the feds have more leeway with banks than they would with other types of business enterprise. How much leeway is an issue beyond my ken.

But there is one thing I am sure of: If this is the route we go down, the government had better get in and out as quickly as possible. If it is done right, nationalization will be the wrong word to describe the process.

Greg Mankiw today addresses an issue which has been nagging at me, but I have neglected to address. I've gotten a fair number of comments along the lines of "I'm opposed to bank nationalization, but I agree we need to do something, so put them in bankruptcy."

Aargh. No one seems to have a problem with the FDIC shuttering bank, selling deposits and assets, and figuring out what to do what's left over. Folks, that is a form of nationalization. What most people fail to recognize is that the FDIC tries to minimize how long it is in control The reason the US had to resort to a bad bank in the S&L crisis was the FDIC and FSLIC had so many dead banks landing in their laps, and in particular, banks with some assets that were hard to value (think largely vacant new office buildings in Texas) that the regulators had to get extra funding to deal with the mess and come up with a variant of their usual routine to encourage other buyers to look at some of the bank assets.

The problem is that the procedures that work for small and even fairly large banks do not work for super big bank (so who would buy Citi's deposits and branches, pray tell? And even if such a bank existed, do we want that much concentration? And what do we do with the junky assets, the private equity portfolio, the asset management business, its credit default swaps book, its various trading operations (many, ranging from FX, Treasuries, structured credits, money markets instruments, equities, junk bonds, derivatives, and I'm sure I've missed quite a few). These banks are not simply bigger; they are in a far wider range of businesses than the typical FDIC basket case, with a much larger geographical footprint (typically substantial foreign operations) and more complicated operations (meaning management information systems, financial reporting, transaction processing, customer reporting, risk controls).

It's hard to convey to people outside finance why it isn't the same as a manufacturing business or a retailer, where you can resort to Chapter 11. The simplest may be that banks are much more tightly integrated into various customer and counterparty webs than most other businesses are. If a big automaker wants to shut down a production line for a few hours or a week. it can be done with little disruption to outside parties if planned. It isn't acceptable for a trading desk to shut down for a day, say to do "routine maintenance". Counterparties would run for the hills the next chance they had a chance to initiate trades. Now one might argue that this is convention, but as a customer, not being able to trade, not having ready access to one's funds is seen as an unacceptable risk, and that business requirement makes it impossible to resort to Chapter 11. By definition, creditors are held at bay. That means they CANNOT access their positions (certain changes that were part of the 2005 bankruptcy reform in fact allow certain parties preferential rights, but enough are at risk of being frozen in Chapter 11 that credible information that a trading operation is going down is enough to precipitate a run, as happened with Bear).

I know that that is a gross oversimplification of the procedural issues, but I believe it conveys the essence of the problem.

Mankiw thus favors nationalization, or what he calls, following Calculated Risk, "pre-privatization" as the best fudge we can come up with in lieu of having a regulatory/bankruptcy regime that addresses the peculiar nature of large, possibly systemically important, trading organizations.

From Mankiw:

Why are people scared about the idea of nationalization? One reason is that it is a sign of the depth of our problems. A second, more substantive reason is that it seems to point in a bad direction. I certainly do not want the government deciding who deserves credit and who does not, what kind of investments are worthy of financing and what kind are not. That is a big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.

If the government is to intervene in a big way to fix the banking system, "nationalization" is the wrong word because it suggests the wrong endgame. If banks are as insolvent as some analysts claim, then the goal should be a massive reorganization of these financial institutions. Some might call it nationalization, but more accurately it would be a type of bankruptcy procedure.

Bankruptcy could become, in effect, a massive bank recapitalization. Essentially, the equity holders are told, "Go away, you have been zeroed out." The debt holders are told, "Congratulations, you are the new equity holders." Suddenly, these financial organizations have a lot more equity capital and not a shred of debt! And all done without a penny of taxpayer money!


One of the problems in talking about nationalization is there is very little consensus on what the word means, Indeed, in reading the press, columnists, fellow bloggers, and comments, I can see a wide range of assumptions, hidden and explicit, at work. The more we start clarifying what we mean, the better chance we have of sharpening debate and coming up with viable approaches. And I strongly suspect, as Mankiw's suggest, that the advocates and opponents may have a lot more common ground than they realize.

Feb. 19 (Bloomberg) -- Poor judgment by bankers helped get us into this crisis. They relied too much on borrowed money, lent too freely to shoddy customers and got taken in by their own sophisticated financial models.

So you would think the last thing anyone would want to do is rely more heavily on their judgment in the hope they’ll do better next time.

Unless, that is, you’re a banker. Many believe one way to prevent today’s troubles from recurring would be to give banks more wiggle room over how much money they put aside to cover loans that might go bad. That would let them build up rainy day funds when times are good so they can bolster profit during slumps.

Too bad this kind of smoothing of earnings won’t help restore confidence. It also reflects the kind of “it’s not our fault” song and dance that too many bankers are engaging in, both with investors and on Capitol Hill.

If we want banks to store nuts for winter, let’s prevent them from paying out too much in dividends and share buybacks during good times. Those outlays wouldn’t lead to games with earnings that can give investors a false sense of comfort.

Consider that between 2003 and 2007 Citigroup Inc. paid out about $44 billion in dividends and about $22 billion buying back stock. The combined outlay is about four times more than its current market value, and much more than what the government has shelled out to keep the bank afloat.

Little Faith

A little restraint back then might have left Citi in better shape today. Instead, investors wind up with little faith in banks’ books. Their numbers are so dubious that Treasury Secretary Timothy Geithner now wants special stress tests to figure out which banks can survive without more government handouts.

What’s amazing is that after all this, bankers want even more leeway over reserves for potential soured loans, one of the most subjective areas of the balance sheet. That’s because these estimates involve guesswork about borrowers and economic conditions, now and in the future.

Some bankers believe onerous rules regarding the way these reserves are calculated prevented them from building up enough of a buffer before the current crisis exploded.

The problem is these reserves can easily be used by banks to manage their numbers, or manipulate earnings.

and btw, Yves is a woman.