Not even the most generous observer would say that the Treasury and
the Fed have done a good job of explaining the thinking behind their
financial stability plan. I think this note by Douglas Elliott does a much better job than they have. If you want to understand the logic of the administration's position, have a look.
On the underlying analysis, Elliott is with Geithner and Bernanke most of the way, which lately puts him in the minority of commentators. The main difference is that he is willing to say that outright nationalization might be necessary for "one or two" large banks, whereas Geithner and Bernanke persist in giving the impression that they will avoid this if at all possible. Most economists who follow this subject now seem to be arguing for outright nationalization of many banks--or, as they put it, "the banks" (choose your own number). People often seem to be talking past each other. Elliott persuades me that some of the discussion of the Fed/Treasury plan is muddled by terminology.
This week Bernanke said nationalization is "when the government seizes the bank, zeroes out the shareholders, and begins to manage and run [the] bank, and we don't plan anything like that... I think that this debate over nationalization kind of misses the point." ("Bernanke Pushes Back Against Nationalization", said the headline in the WSJ.) But he does not exclude bigger public stakes (with taxpayer upside) and strong control rights: indeed, that is what he is proposing. So, as Elliott says, a lot depends on exactly what you mean by nationalization.
Elliott also explains the "franchise value" and "legal complexity" arguments for avoiding full nationalization unless it is really necessary; Bernanke mentioned those points in testimony this week but did not elaborate. The paper carefully goes through the pros and cons of full nationalization. I've been leaning towards that solution but the paper did make me pause. This is how it wraps up.
It] may prove necessary as a last resort for one or two of the larger banks, but should only be undertaken when, and if, it is clearly necessary. More widespread nationalization is unlikely to be needed unless the economy performs substantially worse than most economists expect. Although we all crave certainty, it would be better to wait until we knew that this pessimistic case was likely before nationalizing more widely, given the serious social and financial costs of that extreme step.
Beyond the very small number of full nationalizations that may prove necessary, it may well make sense for the government to take substantial stakes now in additional large banks in a form that some may view as a partial nationalization. The Administration's plan to perform a rigorous, uniform "stress test"on the nation's largest banks is a good one...
[If] it becomes clear through the stress test that a bank is already insolvent or is at high risk of becoming insolvent, then it would be better to go directly to the step of full nationalization...
Many observers would say that most of the banking system is "already insolvent" or "at high risk of becoming insolvent". The Fed and the Treasury evidently think otherwise. ("If a bank does become insolvent then the FDI, of course, will intervene," Bernanke said on Tuesday, "but we're not close to that. All the banks are above their regulatory capital.")
Perhaps Citi and Bank of America--to name two large
banks--are or will be insolvent on any plausible scenario; for the rest
of the industry it still hinges on the timing and strength of the
recovery. Hence the Fed/Treasury stress test.
Is the "adverse" case in that exercise--an output decline of 3.3% this
year and 10% unemployment in 2010--adverse enough to tell us what we
need to know? I wonder. It's not difficult to imagine a worse case than
that.
Anyway, take a look at Elliott's article. Even if you don't agree with the conclusion, I think you'll find it helps to clarify the issues.
I thought that it was a good article, but I'd like to make a few points:
1) What he details as the conditions for nationalizing some large banks is what many of us who backed a version of the Swedish Plan were calling for in September. In other words, we weren't calling for banks to be immediately seized, but for setting up a process that could do so for large banks if it became necessary. Not setting up such a plan has been a huge mistake.
2) These large banks do have assets, but my understanding is that nobody trusts them enough to buy from them. Buyers would need a subsidy from the government or fire sale prices. That's the current situation as I understand it. They are trying to unload some of these assets.
Initially, I thought that the stress test might ease some of these buyers concerns by having the government, in essence, vouch for their bottom line. But there is a potential problem, which is that the government will lose trust and, even if we take these assets over, we're going to be unable to sell them for anything but pennies on the dollar. In other words, there could be a downside in waiting if conditions deteriorate.
3) The taking over one or two banks is preferable, but we keep hearing about a contagion. Once again, the whole point of having the conditions spelled out clearly, as in a version of the Swedish Plan, would have made this much less likely to occur.
I mention this because I believe that we might be paying a terribly high price for letting fear of nationalization get the better of pragmatism, and we might well be continuing to do so.
Both Bernanke and Elliott appear to be mistaken in one technical respect that also affects the overall tone of what is being proposed. Nationalization, as currently contemplated, does not involve "zeroing out" the shareholders or "transferring" ownership from shareholders to the government. There should be no implication of government seizure or, worse, expropriation.
Instead, nationalization would involve the acquisition by the government of newly-issued common shares in amounts large enough to cause significant dilution of the interests of existing shareholders -- moreso in "full" than "partial" nationalizations, but never enough to divest existing shareholders entirely. A shareholder will own the same number of shares post-nationalization as pre-nationalization; those shares will just represent a smaller (perhaps even vanishingly small) percentage of the aggregate outstanding.
The Administration's Capital Assistance Program would not even deprive existing shareholders of their right (under corporate charters and/or stock exchange rules) to approve the issuance of the new shares, although the proposed terms would impose fairly draconian (but typical) penalties in circumstances where shareholder approval is not timely obtained.
Just saying, we're not third world kleptocrats, here.
Please have a look at the Peterson Institute for International Economics blog. Anders Aslund, who was involved in the Swedish bank clean-up explains that there was no nationalization of Swedish banks. There was only one bank, which was bankrupt, that was merged with a state-owned bank. He also offers a great idea for separating out bad assets to keep them from contaminating the whole financial system.
http://www.petersoninstitute.org/realtime/?p=504