Friday, February 20, 2009

Nationalization Jibber-Jabber

"Citigroup (C) and Bank of America (BAC) won’t live to see May. The government will take them over within the next 60 days. The announcement may come as soon as tomorrow evening."
-- The Motley Fool, Friday, Feb 20
There's been a lot of uninformed, hysterical jibber-jabber on the Tee-Vee and the Internet Pipes about the evils of nationalizing some banks over the last week or two.

It reached a fever pitch today, mostly generated by stock hypsters like Rick Santelli at CNBC. Santelli is not a real economist, by the way. He just plays one on the Tee-Vee.

Paul Krugman, the Nobel Prize winning economist, states the becalming facts in a nutshell:
We are not talking about fears that leftist radicals will expropriate perfectly good private companies. At least since last fall the major banks — certainly Citi and B of A — have only been able to stay in business because their counterparties believe that there’s an implicit federal guarantee on their obligations. The banks are already, in a fundamental sense, wards of the state.

And the market caps of these banks did not reflect investors’ assessment of the difference in value between their assets and their liabilities. Instead, it largely — and probably totally — reflected the “Geithner put”, the hope that the feds would bail them out in a way that handed a significant windfall gain to stockholders.

What’s happening now is a growing sense that the federal government, in return for rescuing these institutions, will demand the same thing a private-sector white knight would have demanded — namely, ownership.
What's more, as Krugman and Nouriel Roubini and James J. Galbraith and just about every other economist, left and right, has said repeatedly, federal "ownership" would be temporary. It would work exactly like an insolvency proceeding, as Atrios (economist Duncan Black) explains. Indeed, it already does. It's been happening to smaller banks, now, and even large ones like Washington Mutual nearly every Friday.

To be sure, when a bank becomes insolvent and is "nationalized" by the FDIC or some other government insurer or court, common shareholders suffer severe dilution in their investment, at best; more frequently, as in any other insolvency proceeding common shareholders are wiped out altogether.

But preferred shares may retain some fractional value, depending on the severity of the insolvency. And, of course, the creditors are by law given priority to recoup as much of the debt possible; most especially, government creditors like the FDIC that guarantee customer deposits.

Creditors usually are only ones who stand a chance of getting something back on the dollar. Just as in corporate bankruptcy proceedings, they are handed the power to take over management and wind up company affairs by paying off customers of the bank and creditors.

As economists Mathew Richardson and Nuriel Roubini explained two days ago in the Wall Street Journal, there is no other rational option when the banks are essentially broke:
Once we face this truth, there really isn't much left to do but nationalize.

We are not talking about the government operating the banks for the long-term. But, as was done in Scandinavia in the early 1990s, we are talking about orderly clean up, then reselling the banks to private investors.

"Clean up" and "receivership" sound so much better, don't they? More orderly, more lawful. So if you're a free market purist, you don't have to use the 'N' word. Use the "R" word for "receivership." It will make you feel better.

Unless, that is, you happen to hold common stock in Citigroup or Bank of America.

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