Nationalization is Coming

Its clear that the occasional side conversations are entering the mainstream. Heck, even Lindsay Graham, John McCain, and Alan Greenspan seem to be on-board.

There are four assumptions you need to buy into to think this is the ‘least bad’ option:

1) Speed trumps ideology — Part of the nationalization argument says that in order for recovery to begin, we need to flush out the bad loans as soon as possible. The Japanese experience is the lesson here — you can let zombie banks hang around and they will, for a long time, but they won’t provide the capital the economy needs to grow again.

2) Counterparty Risk is primary — This crisis was initially termed a ‘liquidity crisis’, so the Feds lent a ton of money and invested a ton of money. Still not helping. The issue is that no one trusts anyone else. Until you take the dodgy assets out of the mix, no one will.

3) Subsidies and prices matter — First, prices — Citigroup now has a market cap of $16.5b; the US Gov’t has injected $45b directly and guaranteed $300b in assets. How much more government money can you put into the entity and still say with a straight face that it hasn’t been nationalized?

Next, subsidies — almost any conceivable variation of the ‘bad bank’ plan, be it solely government run or the latest public-private partnership version, involves a subsidy to someone. If the gov’t overpays, the bank’s shareholders and managers get a subsidy. If the gov’t provides a guarantee in the context of the public-private plan, the private equity investors get a subsidy.

If the government doesn’t pay enough, the banks won’t sell the bad assets because its better to have bad assets on your balance sheet at higher valuations then to put a price to those assets and discover that you might be insolvent. You see the circular nature of the problem?

In a nationalization scenario, the gov’t owns the entire bank, splits the assets into bad and good piles, then (ideally) sells the remaining good pile. (The only hitch with this simplistic scenario is that you then have a publicly-managed bank making lending decisions (ask the Germans about that one) and its not clear how long before they can be sold to private entities.)

4) The market is irreparable locked — This may be the most important one — if you think that we come out of this at some point, then the status quo makes sense, why get the gov’t in the business of outright ownership, let the banks limp along until these bad assets become..umm…slightly less bad. But if you think that the economy can’t rebound until these bad assets are accurately disclosed and repriced, then maybe you start to think the (once) unthinkable.