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Bank nationalization - not as bad as it sounds

Reuters is reporting that many analysts are sceptical of the desirability as well as the effectiveness of any form of nationalization of US banking sector. A variety of arguments are being offered by these people in support of their stand against such a move:

  1. It is insufficient to stem the slide in fortunes of the receiving entities, e.g., Citigroup
  2. It is detrimental to the interest of the shareholders
  3. It will also penalized "relatively healthy" banks as investors will offload their stakes from the entire sector
  4. It poses a question of moral hazard as the government will play a dual role, that of the regulator as well as that of the benefector
  5. It will lead to such calls from other sectors also, most notably the automobile sector

While all of the above arguments are valid, they miss a simple & oft-repeated, yet crucial, point - the current crisis is unique in more ways than one and that it will require unique approaches to solve it

At a fundamental level, all of the above objections can be boiled down to the analysts' firm belief in the traditional definition of capitalism and the US role as the epitome of a free market society. However, capitalism has come to be the dominant economic theory precisely because of its ability to evolve and adjust to the prevalent socio-economic conditions. To use a software-terminology, capitalism comes in many flavours - from the unadulterated Friedmanian version to the moderate Keynesian version

Coming to the question at hand, government taking majority control of (for example) Citigroup will help in the following ways:

  1. It will ensure that Citi will survive, no matter how much more losses it has to absorb before the current crisis ends
  2. It will benefit the investors and the stockmarket in the longer run by forcing them to be more realistic about the returns that they can expect from a company and make them directly take on the risks that come with unrealistic expectations
  3. It will encourage other, so-called "healthy" banks to be more forthright about their real fiscal positions - I still don't understand as to how can there be such a huge gap in what Citigroup wants to convey ("we're one of the strongest banks")and what the market wants to believe ("it is a gone case")!
  4. There cannot be such a big conflict of interest in the current scenario; the US govt stands to lose as much as any other stockholder and it would want the regulators to be more effective & efficient in safeguarding its interests
  5. It will comfort the broader national and global economy is that the US is indeed "walking the talk" as far as tackling the crisis heads-on is concerned. One should not under-estimate the psychological impact of such a move on the people as well as the markets

Last but not the least, the analysts should not forget that this is purely a temporary measure and can be rolled back as & when the situation so permits!

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Comments: (4)

A Finextra member
A Finextra member 27 February, 2009, 15:10Be the first to give this comment the thumbs up 0 likes

It is against market and it will not benefit anybody.

Citi should have been taken over by its creditors. Shareholders would have been punished for their mistakes and creditors would have to cover all loses, sic, to themselves. They created pyramidal scheme, they gambled and they lost.

What was so unacceptably ugly about this solution? Probably the offered price was the right one, but unacceptable for Governments. Why?

Real losers ,and that is not mentioned yet, are all those house an business owners that were prudent - didn't borrow too much, didn't speculate, didn't get into the market only to sell at the top, but have to pay inflated mortgages.

FSA accepted one part of the ruinously bad regulatory politic. When will FSA accept the rest? 

A Finextra member
A Finextra member 28 February, 2009, 05:48Be the first to give this comment the thumbs up 0 likes

Unfortunately, it is like getting stuck between the devil on one side and the deep blue sea on the other! What you have pointed out is very valid - borrowers who borrowed within their means and are regular in repaying their mortgages should not be forced to subsidize those who were careless. Likewise, lenders who managed their risks properly and who did not get too greedy should not be penalized alongwith the rest of the industry

However, the situation is now so dire that not rescuing the irresponsible players will likely drown the responsible ones as well. The fundamental reason is the magnitude of the crisis and the humongous amounts of bad debt/credit (they are two sides of the same coin, aren't they?!) that are choking the money flow

I think a reasonable way out is to ensure that the bad apples are made to pay more for their mistakes in the long run. Of course, the devil is in the details & it remains to be seen if political considerations hinder rational, economic, decisions

A Finextra member
A Finextra member 28 February, 2009, 22:50Be the first to give this comment the thumbs up 0 likes

I don't think that it is so easy. There is much more of a "fog" in which irresponsible try to hide their share of a blame.

In September Mr King said that "economy has to weaken more to fight inflation".

If banks are taken over by their creditors, creditors would bring new management teams. That is the market way, why is the Government now fighting against it?

Second example - as the value of mortgage books are plummeting, why aren't they offered at a discount to mortgage holders? The Government helps bank involved in this pyramidal scam to keep those in negative equity as a kind of "hostages" as they will have to pay a "ransom" to move to another mortgage provider.

A lot of questions that will have to be answered!

A Finextra member
A Finextra member 01 March, 2009, 08:54Be the first to give this comment the thumbs up 0 likes

Well, yes, the "fog" is definitely there and is unlikely to clear any time soon!

However, I have one concern about letting market forces decide on the fate of the beleagured institutions. The implicit assumption in all these arguments is that the market knows best and that the new management will be able to turn around the companies that they are taking over

The hydraheaded serpent that the CDO & the CDS sector has become is almost entirely a creation of the industry, by the industry, for the industry. Very few outsiders understand (or maybe, are exposed to?) the exact underpinnings of the wheelings & dealings. Heck, even the insiders were not able to fully grasp what they were doing

Under these circumstances, how does one expect a new board to stem the losses and restructure the companies, even as they continue to bleed

I believe that this crisis will just have to be allowed to run its course. The financial hole that has been created will only be filled over the time; it doesn't matter if the money is "public" money or "private" money or, as the Obama administration wishes, "public-private" money!

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