Monday, March 9, 2009

It's not a step to be taken lightly, and it's not hard to understand why the Obama administration has declined, so far, to take the plunge.

From Salon:

"How do you nationalize a multinational Godzilla?

When the president of the United States discusses blogs and bank nationalization in the same sentence, you can be certain that the chattering classes of the Web will pay sharp attention.

From the New York Times:

Part of the reason we don't spend a lot of time looking at blogs is because if you haven't looked at it very carefully then you may be under the impression that somehow there's a clean answer one way or another -- well, you just nationalize all the banks, or you just leave them alone and they'll be fine, or this or that or the other. The truth is this is a very complex set of problems and bad decisions can result in huge taxpayer expenditures and poor results.

Classic Obama: Cautious and appreciative of nuance and complexity. If he was trying to signal that his administration intends to move carefully, all the better. But even the most strident advocates of immediate nationalization will accept that there is no "clean" answer to the banking crisis, nor would they deny that the Obama administration is facing "a very complex set of problems." They would be much more likely to argue that nationalization is the least dirty option currently on the table, and time is of the essence. The longer we wait before recognizing this, the more taxpayer money we are going to piss away trying to keep sinking ships afloat.

The Obama brain trust may realize this. But they also have a pretty good reason for not immediately heeding the calls made by the likes of Paul Krugman, Joseph Stiglitz and former IMF chief economist Simon Johnson to seize the commanding heights of Wall Street. It's simple: We haven't ever really attempted nationalization on the scale posed by, to pick just one not-so-random example, a multinational monster like Citigroup.

For the purposes of clarity, let's repeat here the de rigueur nomenclature disclaimer that stipulates that the kind of bank nationalization at issue is not the straight-out expropriation of private property by the state that some people find so scary. The FDIC seizes failing banks all the time, cleans them up, and sells them off, and very few people start raving about the second coming of V.I. Lenin and Leon Trotsky. Last week IndyMac, next week Citigroup. What's the big deal?

Well, it turns out that there are some significant differences between a run-of-the-mill failing bank and a Citigroup or a Bank of America. Last Monday, the chairwoman of the FDIC, Sheila Bair, spelled them out, offering three reasons why the government is leery of the "n-word."

1. The legal authority to take over large banks does not currently extend to multinational financial conglomerates;
2. The FDIC lacks the funding to conduct such a massive bailout;
3. Other countries have regulatory oversight of these financial conglomerates too, and they may object to a U.S. takeover.

Time's Justin Fox followed Bair's lead and looked up the relevant numbers on Citigroup, the bank holding company, and its chief subsidiary, Citibank, the bank.

Citigroup has assets of $1.938 trillion, and liabilities of $1.797 trillion. Citibank has assets of $1.227 trillion and liabilities of $1.145 trillion. So right there, about 36 percent of the company's assets and liabilities are outside the bank.

Then there's the bank itself. Its balance sheet separates deposits in U.S. offices, which are insured by the FDIC, from deposits in offices outside the U.S., which aren't. Of $755 billion in deposits, $241 billion are in the U.S. and $515 billion outside (the numbers don't add up because I'm rounding).

After slicing and dicing, Fox determined that if the FDIC seized what it had the legal authority to grab, "this would leave an entity (or entities) with about $1.5 trillion in assets and $1.4 trillion in liabilities to be taken over by foreign governments or fail in pretty much the same unruly manner that Lehman Brothers did." And Fox concludes: "I get why the administration is so reluctant to take over Citi completely."

In practice, all three of the reasons cited by Bair as mitigating against nationalization could be overcome. Congress could give the FDIC the legal authority it needs, in addition to the necessary funding. And the U.S. could work in concert with other nations to engage in the kind of multinational takeover necessary to rescue a flailing multinational corporation. As the president of the Federal Reserve Bank of Kansas City, Thomas Hoenig, argued last week, history proves that "in other countries as well as in the United States, large institutions have been allowed to fail" and "banking authorities have been successful in placing new and more responsible managers and directors in charge and then reprivatizing them." So why not get on with it?

But a Citigroup takeover would still be a major, major undertaking. To do it right will require time and planning, and one would hope that the authorities in question will ensure that whatever action is taken will, in Obama's words, "cauterize the wound" once and for all. As in, let's get all the ducks in a row, and blow them away all at once.

But let's not underestimate the enormity of the task ahead. Just nationalizing one giant multinational bank could send unpredictable shocks through the global banking system. To prevent the entire global economy from crashing, the United States might have to take the extraordinary step of guaranteeing all the liabilities of the U.S. banking system. That, after all, is what Sweden did, when it rescued its own banking system. That's the kind of step that might need to be included in any serious U.S. effort at "nationalization." It's not a step to be taken lightly, and it's not hard to understand why the Obama administration has declined, so far, to take the plunge.


Implicit Guarantees

This idea about implicit guarantees is a little more complicated than you are suggesting. From Zero Hedge:

"Citigroup's 10-K filing makes it clear why regulators appear committed to (or perhaps are stuck with) a strategy of supporting the full capital structure (including holding company debt), rather than subjecting the bank to the Lehman treatment. Citigroup has a daunting $1.9 trillion of assets on the balance sheet alone (not counting off-balance sheet exposure). The balance sheet is essentially supported by an uneasy alliance between the U.S. government and the company's depositors and other creditors, since the market value of the equity is so depressed. Deposits totaled $774 billion at year end, including nearly $500 billion outside the U.S. In a liquidation of a U.S. insured depositary institution, the 10-K notes that U.S. deposits would have priority over deposits outside the U.S., as well as over parent company claims. But we can't imagine the new administration will want to precipitate an international crisis over whose-deposits-get-paid-off-first."

In other words, the government is trying to avoid making a decision about whether or not these foreign assets are implicitly guaranteed by us. China has argued they are, I believe. However, by avoiding a decision, we are in fact implicitly acknowledging that our government is guaranteeing these assets, which is one big reason we're doing this. The only way to not implicitly guarantee these assets would be to forthrightly deny that we guarantee them. Whether this is a wise policy or punting or wishful thinking is hard to tell at this point, but we shouldn't kid ourselves that it has consequences.

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