Seeing The Bigger Picture On Bank Nationalization

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“It is inevitable the banks will be nationalized. The longer we dawdle, the more expensive it’s going to be. Let’s just rip the Band-Aid off and get it over with.” – Barry Ritholtz, CEO and Director of Equity Research at FusionIQ quoted in Barron’s 2/23/09

Ritholtz is probably best known to readers for his popular financial blog, “The Big Picture.” As much as I admire and respect his success in the blogosphere, Ritholtz and others who are clamoring for bank nationalization (see his list), fail to see the bigger picture.

Most of the people in favor of nationalizing the banks fail to define nationalization (and journalists fail to ask). Is it a 100% government controlled takeover like the UK government did with Northern Rock and the FDIC did with IndyMac? Or is a government majority takeover such as the 79.9% solution imposed on American International Group (AIG) and Fannie Mae (FNM) and Freddie Mac (FRE) enough? Perhaps the government as the largest equity holder based on market capitalization would suffice and already qualify Bank of America (BAC) and Citigroup (C).

A joint statement issued yesterday by the Treasury, FDIC, OCC, OTS and the Federal Reserve stated: “Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands." However, countering the repeated assurances is the Administration’s refusal to unequivocally reject (or at least clearly define the government’s definition of) nationalization. Confusion and uncertainty as to what the government’s intentions are and more critically, the government’s conflicting objectives, has only escalated the turmoil and aided and abetted short sellers. (Notice the deafening sound of silence by the Administration/SEC on shorting.)

Although I must unfortunately disagree with Federal Reserve Chairman Bernanke’s optimistic economic forecast given during his semiannual monetary policy testimony today, I commend him for discounting the “zombie bank” rhetoric, stating: “I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn’t necessary.” My definition of a “zombie bank” is a bank that strategically shrinks its balance sheets to match its capital, instead of increasing its capital and lending for the “benefit” of our economic recovery. A true capitalist would allow the zombies to find their own way, versus a communist would want to control them.

Barry Ritholtz and others pushing for bank nationalization do not differentiate between building and destroying, only the promotion of what a capitalist can profit from. These nationalistas might view Venezuelan president Hugo Chavez taking over an oil field for the “benefit of the people” as socialism, but a Treasury Secretary who confiscates a weakened Fannie or Freddie is acting as a Darwinist for the benefit of the “taxpayers.” Another example is the free marketeers who have no problem with the sacrifice of a weakened AIG to save the Golden One (GS). A nationalista capitalist believes it’s okay to feed the weak to the strong with the aid of a not to be called socialist government.

Most nationalistas will emphasize they only want to see banks nationalized “temporarily.” Former Fed Chairman Greenspan and Nouriel Roubini want the government to nationalize banks and then break up their components. And since the nationalistas are short on details, I think this is a good place to begin using Citigroup as an example of the need to see the bigger picture.

What would nationalization of Citigroup entail? Optimistically it could mean the FDIC seizes Citibank and leaves the Citigroup holding company including the remaining domestic and foreign subsidiaries to the shareholders. While that seems unlikely, if the U.S. government has majority ownership in the holding company it faces the dilemma of owning banking institutions in foreign countries. Foreign governments would not take kindly to this. And neither would the CIA who would lose intelligence gained through access to Citigroup’s foreign transactions and money flows. Some of the most challenging issues the government would face once they take a majority interest would be the prevention of social good overwhelming the ability of Citigroup to be nursed back to health as a sound institution. We only have to look to Fannie and Freddie to see an example of social good overwhelming financial soundness.

Finally, the government would have to find a way to prevent smothering an inefficient decision making process with approvals required at the top for all substantive decisions. Unfortunately Citigroup and other financial institutions were overwhelmed by the creations of financial rocket scientists and the government might find it difficult to employ talent equal to the task of unraveling their monstrous creations.

And if that wasn’t enough, Washington’s need to reign in salaries and perks would make it difficult to attract the level of talent needed to unwind Citigroup. After the government has killed the common stock they wouldn’t have anything to offer a new set of Citigroup executives. A more careful review should lead the government to finding a way of boosting Citigroup’s stock in the open market versus diluting it. I recommend that the government encourage private ownership of Citigroup common stock by converting the TARP preferreds at a price far above market. The political backlash would be short-lived and all banks would gain from the inevitable short squeeze. This would be a far cheaper and less risky way to restore confidence than nationalization.

No disclosures. The actions by the government, the shorts, and the nationalistas drove me out of financial stocks. When the government finally realizes that a component of a healthy financial system depends on shareholders, my shopping list will be ready.

1 comment:

Ritholtz said...

Here's my definition:

FDIC mandated, pre-packaged Chapter 11, government funded reorganization.