Tuesday, February 10, 2009

Obama on Nationalization

by Bill McBride on 2/10/2009 05:34:00 PM

Terry Moran at ABC News interviewed President Obama today (airs tonight). Here are some excerpts: (hat tip Paul Kedrosky)

TERRY MORAN: There are a lot of economists who look at these banks and they say all that garbage that's in them renders them essentially insolvent. Why not just nationalize the banks?

PRESIDENT OBAMA: Well, you know, it's interesting. There are two countries who have gone through some big financial crises over the last decade or two. One was Japan, which never really acknowledged the scale and magnitude of the problems in their banking system and that resulted in what's called "The Lost Decade." They kept on trying to paper over the problems. The markets sort of stayed up because the Japanese government kept on pumping money in. But, eventually, nothing happened and they didn't see any growth whatsoever.

Sweden, on the other hand, had a problem like this. They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you'd think looking at it, Sweden looks like a good model. Here's the problem; Sweden had like five banks. [LAUGHS] We've got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would -- our assessment was that it wouldn't make sense. And we also have different traditions in this country.

Obviously, Sweden has a different set of cultures in terms of how the government relates to markets and America's different. And we want to retain a strong sense of that private capital fulfilling the core -- core investment needs of this country.

And so, what we've tried to do is to apply some of the tough love that's going to be necessary, but do it in a way that's also recognizing we've got big private capital markets and ultimately that's going to be the key to getting credit flowing again.
Kedrosky comments:
[S]aying that Sweden had five banks and the U.S. has thousands, so nationalization can’t happen here, is misleading. It ignores the relative GDPs of the two countries. ...[and] the problem is chiefly in the six largest U.S. banks ...
On the issue of "cultural differences" between the U.S. and Sweden, I've joked that we should call taking over the banks "preprivatization" to avoid the stigma of "nationalization".

But stop and think about what Obama is saying. We know the correct answer, but we are afraid to do it - because of our "culture" - so we are going to follow the Japanese plan.

We should definitely stress test the banks. My suggestion: announce when this will be complete (within 30 days), make the results public, and preprivatize the insolvent ones.

Update: Roubini: It Is Time to Nationalize Insolvent Banking Systems. Excerpt:
[W]hy is the US government temporizing and avoiding doing the right thing, i.e. take over the insolvent banks? There are two reasons. First, there is still some small hope and a small probability that the economy will recover sooner than expected, that expected credit losses will be smaller than expected and that the current approach of recapping the banks and somehow working out the bad assets will work in due time. Second, taking over the banks – call is nationalization or, in a more politically correct way, “receivership” – is a radical action that requires most banks be clearly beyond pale and insolvent to be undertaken. Today Citi and Bank of America clearly look like near-insolvent and ready to be taken over but JPMorgan and Wells Fargo do not yet. But with the sharp rise in delinquencies and charge-off rates that we are experiencing now on mortgages, commercial real estate and consumer credit in a matter of six to twelve months even JPMorgan and Wells will likely look as near-insolvent (as suggested by Chris Whalen, one of the leading independent analysts of the banking system).

Thus, if the government were to take over only Citi and Bank of America today (and wipe out common and preferred shareholders and also force unsecured creditors to take a haircut) a panic may ensue ... Instead if, as likely, the current fudging strategy - of temporizing and hoping that things will improve for the economy and the banks - does not work and in 6-12 months most banks (the major four and the a good part of the remaining regional banks) all look like clearly insolvent you can then take them all over, wipe out common shareholders and preferred shareholders and even force unsecured creditors to accept losses ( in the form of a conversion of debt into equity and/or haircut on the face value of their bond claims) as the losses will be so large that not treating such unsecured creditors would be fiscally too expensive.

So, the current strategy – Plan A - may not work and the Plan B (or better Plan N for nationalization) may end up the way to go later this year. Wasting another 6-12 months to do the right thing may be a mistake but the political constrains facing the new administration – and the remaining small probability that the current strategy may by some miracle or luck work – suggest that Plan A should be first exhausted before there is a move to Plan N. Wasting another 6-12 months may risk turning a U-shaped recession into an L-shaped near depression but currently Plan N is not yet politically feasible.

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