So to nationalize large insolvent banks--and minimize the fiscal costs and financial collateral damage and systemic risk of such a takeover

TO BE NOTED: From Forbes:

"We Need A New Insolvency Regime For Banks
Nouriel Roubini, 03.26.09, 12:01 AM ET

Finally, after a year of delays, the Treasury secretary and the Fed chairman have agreed about the need for a new insolvency regime for systemically important financial institutions (bank holding companies and non-bank financial institutions). This new insolvency regime will allow government to take over in an orderly way--as opposed to a disorderly Lehman-like bankruptcy--insolvent systemically important financial institutions.

This new conservatorship/receivership regime of insolvency could be similar to the one used to manage the orderly takeover of Fannie Mae and Freddie Mac. While banks have a receivership regime based on the Federal Deposit Insurance Corp. taking over insolvent banks and working them out in an orderly way, bank holding companies and non-bank financial institutions do not have such a conservatorship/receivership regime outside of Chapter 11 or Chapter 7 bankruptcy.

That is why the government had to bail out the creditors of Bear Stearns and AIG, and why the collapse of Lehman was disorderly. We need an orderly system to wind down systemically important financial institutions and bank holding companies as many assets, credit default swaps and bonds of banks are at the holding-company level, rather than at the bank level.

Suppose the government was planning to nationalize a large bank--say Citigroup, for the sake of argument--that was to be deemed insolvent after the appropriate stress test. While the FDIC could then take over the bank, the relevant bank holding company would not be under the FDIC receivership; it would instead go into a Chapter 11 or Chapter 7 bankruptcy. And the other non-bank components of such large financial institutions--its broker dealer, insurance companies, etc.--would also end up in Chapter 11 bankruptcy.

So in order to orderly take over large, systemically important banks, the FDIC receivership model works only for the bank leg of the bank; it does not work for the bank holding company or for its non-bank financial arms.

And certainly FDIC receivership does not apply to independent broker dealers and other non-bank financial institutions for which a disorderly in-court bankruptcy is the only option. An orderly wind-down of Bears Stearns or Lehman or AIG would have required a special receivership/conservatorship, as Chapters 11 or 7 would have pushed into automatic default the unsecured debt of these institutions and triggered a mess with their credit default swaps (CDS).

That is why the government decided to bail out--at huge cost to the taxpayers--the creditors/counterparties of Bear Stearns and AIG; and when it decided not to bail out the creditors of Lehman, a global financial meltdown followed Lehman’s bankruptcy. This is also the reason why the government has been, so far, wary of nationalizing large, systemically important banks.

A special insolvency regime would give the Treasury time to figure out whether the unsecured debt of the institutions should be worked out, and how it should be worked out; it also allows a more orderly workout of CDS and other credit derivatives issued by the financial institution.

Thus, the signal given by Messrs. Bernanke and Geithner--of their support of a special insolvency regime for systemically important non-bank financial institutions--is very important. It will allow the orderly takeover/nationalization of large banks and the same orderly takeover of non-bank financial institutions.

It is high time to pass legislation that enables this special insolvency regime. If such a regime had been in place a year ago, the expensive bailout of the creditors/counterparties of Bear Stearns and AIG could have been avoided, and the collapse of Lehman would have also been prevented.

Similarly, today--as soon as the stress tests are done--some large and systemically important banks (and their holding companies and non-bank financial arms) will have to be taken over. To do it an orderly way, we absolutely need a special insolvency regime like the one we have for the bank arms of bank holding companies, and like the one we had for Fannie and Freddie.

So to nationalize large insolvent banks--and minimize the fiscal costs and financial collateral damage and systemic risk of such a takeover--we need to pass such legislation immediately. The time for Congress to act is now.

Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes."