Redefining the sacred in the banking rescue

By J Saft
February 27, 2009

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

Another week, another set of protestations that U.S. banks will remain in private hands, apparently almost regardless of the consequences.

It is clear that nationalization violates a sacred value for U.S. policymakers, or perhaps they believe it to be a sacred value held by voters. As we know from behavioral economics, when people are confronted by a conflict between material advantage and their ideas of the sacred, they tend to opt surprisingly often for the sacred.

Sometimes that is utterly right, but in this case it is really a false opposition. The Federal Deposit Insurance Corporation takes control of failed U.S. banks almost every Friday, and while taking some of the biggest over would pose huge problems, it should be possible to do it, to speed recovery and to hang on to what is essential: a market-driven system of capital allocation and a credible 3- or 4-year glide path to privatization for those assets and institutions that end up in taxpayers’ hands.

Fed Chairman Ben Bernanke added his voice to those maintaining that the crisis would be contained — no, wait, that was 2007’s line — that the banks wouldn’t be nationalized.

“I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn’t necessary,” Bernanke told the Senate Banking Committee on Tuesday.

“What we can do is make sure they have enough capital to fulfil their function and at the same time we exert adequate control to make sure that they are doing what is necessary to become healthy and viable over the longer term,” he said.

“Franchise value” is a risible concept for many of the banks in question. Who will choose to do business with a bank whose shares are trading at penny levels, even if their deposits and funding are essentially backstopped by the United States? My guess is that it really only happens where that institution offers better than market terms to its clients, which in essence is a subsidy via the government and exactly the kind of market distortion those who oppose nationalization say they wish to avoid.

And while “legal uncertainties” are regrettable, let’s get real; we are operating in a time of huge and immediately unresolvable uncertainties, legal and otherwise, not least how contracts underlying mortgage backed securities will be handled as part of the effort to stave off foreclosure.


There appears to be some movement beneath the serene anti-nationalization surface. It is interesting and encouraging that the United States is reportedly considering converting some of the preferred securities it holds in Citibank and American International Group ultimately into common equity. Even better, it may decide to do the same with other past and future equity infusions, with the idea being that banks found wanting under the upcoming stress tests get an infusion of capital that would convert to equity as needed.

I see this as part of the process of the U.S. renegotiating what is and isn’t sacred. The problem with the old preference for preferred shares was that, while it checked the box of providing regulatory capital to banks, it did nothing to entice equity investors into holding their shares or committing new capital. Anyone could see that when the freight train of losses struck the bank’s balance sheet, ordinary shareholders would take the first hit.

Sadly, in their acrobatics to avoid putting banks into government control, the U.S. authorities risk becoming like a hospital that finally decides to use the wonder drug of common equity on patients who have already died.

What the government needs to do is real triage, leaving some to fend for themselves, giving those with genuine hope support — and common equity is the way to do that — and euthanising the zombie banks. Some of those in the middle might just end up with the government as majority shareholder.

George Magnus of UBS points out that there are two key issues that need to be resolved before normal growth can be restored and deflation staved off. First, debt needs to be paid down (or openly defaulted) and savings built up. Second, the financing system needs to be restored to health.

If we don’t hurry up with the second, the retrenching will be deeper and we may long for a scenario akin to Japan’s lost decade.

Remember, we already have the state directing credit into parts of the financial system. If the state supports zombie banks but exercises influence over them, rather than either controlling them directly or having a transparent arms-length relationship, we end up with a very bad scenario: state-controlled lending without transparency or true accountability.

— 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. —


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

How about a novel approach to fiscal fitness: follow the laws and capital regulations for institutional soundness, and stop trying to spin gold out of straw. Go back to basics, and earn money from lending and interest.

All of these huge banks are bleeding money. None of them are actually making money, unless you count running the printing press as “making money”

Posted by phoenix1 | Report as abusive

You are correct Mr. Saft when you note people will often chose the sacred over material advantage. Perhaps our choosing to find some way to solve all of our crisis with capitalism as the vehicle for action is an example of this very same behavior.

Governments look for measures to encourage sustainable energy convservation and use through tax incentive and allocation of said resources. Or, when fossil fuels are expensive enough innovation and new technology will become an affordable alternative.

The unfortunate truth is that the contracting world economy is keeping fossil fuels so inexpensive as to stifle the implementation of sustainable alternatives. Furthermore, some would argue, raising taxes to fund sustainable energy implementation would hamper the economy’s recovery.

Similar arguments are being made to forestall health care, pension, education and infrastructure improvements. While convincing arguments have been made to support substantial investment in these areas, little progress has been because of a lack of market forces and political will to move us forward. I believe no such market forces will ever come to pass.

At some point we must recognize that “capitalism” is our most sacred of cows and the greatest obstacle to moving forward on issues that don’t present considerable opportunity for profit. Harry Truman saved this nation billions of dollars as the Senator responsible for seeing that contractors did not overcharge the U.S. government during World II. Simply put, the war was not entered into as profit seeking venture. As a nation we must find the same resolve if we are to succeed in our struggle to save our society, civilization and planet.

Posted by Anubis | Report as abusive

Are we better off with:
a. zombie banks protected/controlled by treasury, fed
b. ‘lehmanized’ banks that are simply let go into chaos
c. the slow ‘winding down’ approach used with AIG
d. have the gov’t take over the banking system as it has the student loan sector (my guess is commentator “anubis” might favor this approach)
e. none of of the above (caution: if you pick this, you MUST offer a suggestion of your own!)

Posted by lgrtwo | Report as abusive

I guess anything is worth a try including nationalization. Is it really all a shell game? We force some lenders to buy toxic assets from the banks. The lender has to borrow from a bank to buy those toxic assets. He can try to get the money by capitalizing the debt and selling it. This takes money out of the hands of consumers. Consumers then have to withdraw from their savings. Then a whole bunch of other banks holler about having toxic assets that cannot be liquidated. Mickey mouse should stick to Disney cartoons rather than trying to run the economy.

Posted by Don | Report as abusive

Yep, we’re being duped again I mean the keep on repeating the same hollow phrases which we’ve heard from October 2008. Quote Obamam: “I am absolutely confident that…credits going flowing again…” but it won’t cause the whole Global Economy has been halted since the day the keep on repeating these kind of phrases over and over again.

At the same time the U.K. wants to set up a “Shadow Banking System?” to dupe us even more without oversight this time.

I think it’s time that the people start realizing that they have to use the same banking armor which has been used against us. People and Shareholders have to start their own Hedge fund to finally get a place in the Big Boys Game.

Unfortunately people are to stupid to understand this and rather go rioting in the streets with Molotov Cocktails. Same Ol head story, the rich get richer, the stupid get hurt by the rioting police.

Posted by Youri Carma | Report as abusive

[…] For the full story, please click here. Please upgrade your browser […]

Posted by Reuters Columnist James Saft and His View on Bank Nationalisations in the U.S. | Photomaniacal | Report as abusive