Nationalization: Terrible but inevitable

By J Saft
January 23, 2009

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

Nationalization of weak banks in Britain and the United States may be preferable to current plans for insurance and soft “bad banks” schemes which risk being swamped by future losses as assets, especially real estate, continue to crater.

An insurance program, getting banks to identify their riskiest assets to the government which will insure them for a fee, is one of the main planks of a UK plan to bail out banks unveiled this week.

Both Citigroup and Bank of America have already received loss protection arrangements from the government. The betting is now that the United States will opt for some sort of a “bad bank” aggregator which will buy up doubtful assets from banks, with the emphasis on keeping as many as possible operating as publicly traded entities which, once shorn of their bad debts, would be viable and would lend.

Both plans keep banks in private hands, which is desirable, and insurance especially is attractive because it has a relatively low upfront cost. But both, and especially insurance, run a real risk of being too small and, by definition, only ridding the banks of assets that are bad now leaving them to founder on new bad loans later.

Commercial and residential real estate in both countries continues to head south at an alarming rate, with falls of as much as 20 percent or more possible in 2009. Those falls won’t be stopped by current lending programs; it is an ongoing crash that could probably be stopped only by some sort of economy-wide debt writedown which is very unlikely.

That means that we could find ourselves in six or nine months in exactly the same situation, but with banks crippled by a new wave of defaults and with the non-financial economy in a much worse state.

In other words, in order to work a bad bank plan must take into state control the weakest banks and probably needs to err on the side of taking the doubtful down along with the basket cases.

“They should probably nationalize now, but not blanket nationalization,” said George Magnus, senior economic adviser to UBS.

“It is by far the cleaner option, take on all the assets and take on all the liabilities and if you find out that in six months time commercial real estate, for example, has dropped 20 percent it is far less of a shock. You don’t have to treat it as a private vehicle which has to be viable.

“Sell the good bits recapitalized back to the market and you can have viable banks far more quickly.”

DEFINING FAILURE

Consultancy Capital Economics is predicting that British house prices will fall another 20 percent in 2009 and that land values contract by 70 percent peak to trough. British commercial property fell 27 percent last year and analysts in December were forecasting an another 16 percent fall this year. Goldman Sachs economist Jan Hatzius believes the U.S. Case-Shiller 20 City index will fall another 20-25 percent by the third quarter of 2010.

Nationalization is not a good outcome; it is failure defined in a word. And nationalizing banks raises the problem of re-privatizing. Who will want to buy banks from a government with a recent track record of what some will inevitably term confiscation? But few would commit capital to banking now, given that governments have been unable to explain how they will treat capital in the banking system.

If banks are to be taken into state control, there needs to be a process to deal with the rights of shareholders; any bank that stays in state control needs to be run at arm’s length; and the period it stays in state control should be as short as possible.

Easy to say, tough to do and no doubt nationalization will have its disasters.

Bank shares have fallen at an appalling rate on both sides of the Atlantic, with several UK banks trading as if they are in danger of being taken into state control. Royal Bank of Scotland, in which the government already has a 70 percent stake, has lost almost 80 percent of its value in January, while Barclays and Lloyds Plc have fallen precipitously. In the United States, Citigroup has more than halved in value in the month despite equity infusions from the government and an insurance wrapper on some of its assets.

But here is where things differ markedly between the United States and Britain. Britain may well need to do more for its banking system than the U.S. and sadly is less well placed to carry it off without nasty side effects.

The dollar is the world’s reserve currency, allowing the United States more leeway in financing its liabilities, and U.S. banks are smaller as compared to their economy. We’ve already seen sterling falling sharply and you can expect further falls as risk is transferred from the private sector to the state.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click here. –

31 comments

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Thanks to the excesses of Capitalism and the unfortunate greed which was loosened to the extreme under Bush the WORLD will have to experience the new methods: Democrat – Socialism. We got caught with the hand in the cookie jar…..and we are still not letting go…..of few cookies. Helas!…means Hell on us.
Colonialism has been over for a while and still look at the existing colonies of the world!

Posted by Uri Tischer | Report as abusive

Is it just me but does the idea of senior economists, and bankers advising the governments to bail out the banks seem a bit like a mugger asking their victim to give them a hand?
Where did Tony go before all this happened? I’m sure it wouldn’t have happened if he was still PM… after all look at the peaceful results he has achieved in his new role in the ”Middle East”.

Posted by Peter H | Report as abusive

The fact is that at least Citi and BA are insolvent. Either nationalize and warehouse the bad assets or have the FDIC put them in bankruptcy. Anything other than those two options is just going to dither while the economy sinks deeper and longer into recession because it has a dysfunctional financial system.

I prefer nationalization because it’s quicker and because it’s cheaper. The American taxpayer already owns both of these companies via earlier injections. Enough already. The taxpayer doesn’t need to spend another nickel protecting equity investors especially, and cash flow even from warehoused assets can be applied to bond holders in the normal descending order. But once the cash flow is exhausted, the payments stop.

On second thought, if bondholders cannot provide enough capital to make the bank solvent once illiquid assets are warehoused, then take them out along with equity.

Once warehoused, the illiquid securities can be sold, if there’s any market for them. And the taxpayer gets paid back first. If there’s any money left over, then that can be applied as relief for current bondholders in the normal descending fashion.

“Once again, recall the story of banks hiding explosive risk in their portfolios. It is not a good idea to trust corporations with matters such as rare events b ecause the performance of these executives is not ob servable on a short-term basis and they will game the system by showing good performance so they can get their yearly bonus. The Achilles’ heel of capitalism is that if you make corporations compete, it is sometimes the one that is most exposed to the Black Swan that will appear to be the most fit for survival.” From Nicholas Taleb’s best seller, “Black Swan.”

Nationalize first, warehouse. Take your sweet time at the warehouse. Then recapitalize if it is still desired to do so. And what in recent history, for heaven’s sake, would make anyone choose the current bank management?

I would approach the matter in a similar fashion to Beezer. I object to the ‘bad bank’ warehousing notion when it is floated as an idea to ‘save’ the situation, but I agree it makes good sense to isolate and warehouse the toxicity in the course of bankruptcy or nationalization. I do not see nationalization as the ultimate goal here, but a necessary step to address the immediate situation.

Posted by Big Al | Report as abusive

A lot of the issue revolves around the function of banks. Such institutions are not a public service- there is (obviously) a profit motive. Nationalised banks will expect another bubble market into which to sell risky assets- and the ‘greater fool’argument will only hold up in a forever balloning macro-economic environment. If the banks were prepared to take on risky assets and are the victims of en-masse defaults then they must pay the price of failure by disappearing off of the financial radar. There is no real reason why default ratios should disappear! The only sure way to prevent this happening again is (alas) through regulation. If the government has a fiducial obligation to protect the economy for all citizens some areas in the markets must be ringfenced.

Posted by marky pringle | Report as abusive

I agree with you Robynne…this is not a matter of a few banks or financial institutions, it is the majority of the major players and we are talking about our economy, the global economy and our future. How much money are we willing to keep injecting into these banks that are supposed to be lending to the small business sector, private investors, and each other. The small business sector, which is seriously suffering enough as it is, cannot get loans from these banks that will not lend but instead decides to go out and buy another failed institution instead of trying to figure out what happened to their own first. Or maybe they decide to go spend $50 million on a brand new plane, when the bank already has a fleet of them and is not lending but hoarding the funds they received from the Government. And why is the Government not holding them liable for what they spend the money on and how they spend these billions of dollars they are receiving. We, the taxpayers, who eventually have to pay it all back unless the Government returns a profit from “investing” in these failed institutions but in that case we will still end up paying it back in the long run.

I hate to see banks nationalised, but given the current situation the economy is in, it might be something really worth thinking about. At least if the Government nationalised the banks, they would lend to companies that need help right now in order to stay in business, otherwise they will go under which will result in higher losses of unemployment. You might consider, making some amends to shareholders of these banks if you were to nationalise any but as Robynne stated, they run that risk. You never heard them complaining when they were getting large returns, what you heard was less regulation please, and unfortunately our government gave it to them. Now we are facing a situation unlike any of us have seen in this lifetime…globally…maybe not yet but if we don’t make the right decisions now to turn the global economy around, what’s happening right now will be nothing in 5-10 years or less. We need action and we need not be afraid of what these large corporations and banks have to say. We need to stop letting them influence world leaders and decision makers in order to keep lining their pockets.

Posted by Damian Palmares | Report as abusive

They will take this country down with them if we don’t do something about it now. If our economy really tanks…close to the Great Depression levels or worse, what do you think will happen to the rest of the countries of this world who rely on our trade? It’s already starting to show in reductions in GDP and trade surplus from China and other countries. Let’s nip this one before it really gets out of hand and we are there scratching our heads in 5 years from now, thinking hmmmm, maybe nationalising some of these banks might not have been a bad idea after all.

Posted by Damian Palmares | Report as abusive

Capitalism does not have “excesses”. Capitalism is a system that allows individuals to persue their own best interests. Capitalism assumes that self interest in the long term will enforce a measure of honesty. Eventually it does. Madhoff’s time did finally come.

The only regulation required in a capitalist economy is the enforcement of honest disclosure upfront.

If Madhoff told A “give me your money and I’ll give you more money when I can get B to give me some money”, and “I’ll give both A and B more money when I can persuade C, D and E to give me money”, how many of you would line up to F, G, H, and I?

Capitalism (private ownership) is the only means to prevent a tyranny of experts.

The tyanny of experts (Socialism) brought Russia and endless series of 5 year plans that failed miserably. Resulting in institutional poverty ruled by an iron fist of the state.

Chinese Communists ended years of the same economic stagnation by allowing a measure of economic freedom.

Experts brought us Enron, WorldCom, Madhoff, and a host of other “you are too stupid to understand, so trust me” so called experts. Experts brought us the brillant idea that $5.00 Ethanol blended with $4.00 gasoline would save us money.

Capitalism is a system of behaviorial principals founded in individual freedoms. Capitalism does not have excesses. It assumes ready access to information. Insuring that access is the only thing governments need to do to keep the wheels on.

People fail when they abandon long term prinicpals for short term gain.

Posted by Vance | Report as abusive

MY SEVEN STEPS TO SAVING AMERICA

Taking toxic waste (In this case loans that are never going to be paid) and moving that waste to another county (in this case the US Treasury), then shipping it back 5 years later to the county it came from miraculously making potable soil is irresponsible dreaming!

STEP 1 (STOP FEEDING THE LIES)
The first thing that the President can do is stop the phoney-baloney that the Treasury Secretary, Federal Reserve Chairman, and people of the ilk of Robert Rubin, and the Media Like the New York Times are serving up to the public. ALL OF IT to date is complete and utter hogwash. The public can smell a rotten egg and if Obama doesn\’t come to terms with that fact quickly, then he will not spend more than one short term in office.

STEP 2 (BECOME REALISTIC)
All of this nonsense about the Government taking the failed debts of the banks \”temporarily\” to be repaid later is an effort to hide the fact that the Plutocracy of America is more important than the rest of the American People and as they all run for cover the rest of us will be left holding nothing.

STEP 3 (STOP PRINTING MONEY)
As the Goverment continues to print new currency at an alarming rate (that I might add is no longer reported due to M3 no longer being published), we risk Weimarian inflation. We will be carrying 100 Billion US Dollar Notes in the next 5 years at the current rate of inflationary dollar creation.

STEP 4(REVITALIZE MODERN FED.RES.GOLD CERT. RATIO)
There is no solution to the current financial problem that we face, other than creating \”The Revitalized and Modernized Federal Reserve Gold Certificate Ratio\” as per Sinclair.

STEP 5 (HIRE RON PAUL AS SPECIAL ADVISER)
Obama should also make Ron Paul his Special Advisor to work with Volker.

STEP 6 TELL THE ENTIRE COUNTRY THE ABOVE AND EXPLAIN TO THEM WHY IT IS NECESSARY.

Let the Bankers and the Motor companies and any other company that has failed, to fail. Then you will have the trust of the people and other Nations.

STEP 7 (USE THE BIBLE AS YOUR GUIDE)

That’s my solution and it will work if Obama tries it.

Posted by McGregor | Report as abusive