Over the last few months, most of my clients have demanded to know when Washington would nationalize the banks that are "too big to fail." "It won't happen." I responded. "They'll have to." they countered. "They'll partially take them over and call it something else." I concluded.
Here's what I wrote my clients on January 21, 2009:
Bank nationalization only as a last resort. One of the truisms of Washington is that financial markets are almost always ahead of the politicians. For the past week, I've been asked repeatedly about whether we will nationalize our banks, and all I can say is that I've heard no such talk down here. I can assure you that Tim Geithner and Larry Summers have had detailed briefings about the travails of Citicorp and of other financial institutions. Current marching orders remain in place -- fence it off, guarantee some of it, and pump more money in. That appears likely to remain the marching order unless it leads to failure. Last Thursday (1/15/09), Morgan Stanley's Dick Berner recommended the Scandinavian "good bank, bad bank" method to Senate Budget Committee Chair Kent Conrad (D-ND), Ron Wyden D(-OR), and Ranking Republican Judd Gregg (R-NH). None of them sit on the Senate Banking Committee, but they were clearly familiar with the concept. That would be the next possibility if there is a change in marching orders. Nationalization raises lots of nasty political problems. The first is that political leaders would have no one else to blame for further bank problems except themselves -- a non-starter. Second, it would set a precedent that many allies would prefer to avoid. Third, it would prove more expensive for taxpayers in the long-run because Washington would have difficulty spinning off healthy banks into private hands, and, once it did, the massive new federal bureaucracy to manage the banks would remain. Don't assume, Washington policymakers have any idea how much it will cost to save the banks. I am confident that Congress would pass a third TARP tranche if necessary and that it will keep legislating credit market fixes until the credit markets are fixed.
The market's jeers at Washington's failure to nationalize the banks has been clear for all to see. The Dow has dropped 23.5% since the beginning of the year, and 15.5% of that drop occurred in the past month. Financial stocks led the decline.
Monday, FDIC Chair Sheila Bair offered a cogent explanation of why Washington wasn't going to nationalize the banks. She told the Institute of International Bankers meeting in Washington:
I would be surprised if the FDIC had to step in as conservator or receiver of a large, systemically important institution. The regulators' Joint Statement last week restated our commitment to preserve the viability of systemically important financial institutions. This will be done through capital injections, if needed, and the supervisory process.
If more direct intervention to take over a large financial group is needed, that will present significant challenges. The main hurdle is that there's no clear process for resolving a large financial holding company with multiple affiliates. We have a process for dealing with large banks, but not financial conglomerates.
She cited several reasons why Washington won't nationalize the financial conglomerates:
- The legal authority to take over large banks does not currently extend to multinational financial conglomerates;
- The FDIC lacks the funding to conduct such a massive bailout;
- Other countries have regulatory oversight of these financial conglomerates too, and they may object to a U.S. takeover.
The bottom line is that government financial regulation is 100 years behind the times, and our top regulators have concluded that nationalizing Citibank or Bank of America won't work any better than the muddle through approach they have adopted so far. Meanwhile, the market believes otherwise and continues to decline.
