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On Nationalizing the Banks

Early last week, respected economists Nouriel Roubini and Matthew Richardson laid it all out in a Washington Post op-ed Nationalize the Banks! We're all Swedes Now:

"The U.S. banking system is close to being insolvent, and unless we want to become like Japan in the 1990s -- or the United States in the 1930s -- the only way to save it is to nationalize it....Nationalization is the only option that would permit us to solve the problem of toxic assets in an orderly fashion and finally allow lending to resume. Of course, the economy would still stink, but the death spiral we are in would end.

Mid last week, in an interview with Financial Times, former Fed Chairman Greenspan endorsed bank nationalization. "It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring," he said. "I understand that once in a hundred years this is what you do."

The former Fed chairman said temporary government ownership would "allow the government to transfer toxic assets to a bad bank without the problem of how to price them."

But he cautioned that holders of senior debt - bonds that would be paid off before other claims - might have to be protected even in the event of nationalization.

"You would have to be very careful about imposing any loss on senior creditors of any bank taken under government control because it could impact the senior debt of all other banks," he said. "This is a credit crisis and it is essential to preserve an anchor for the financing of the system. That anchor is the senior debt."

And late last week Senate Banking Committee Chairman Christopher Dodd said banks may have to be nationalized for "a short time". "I don't welcome that at all, but I could see how it's possible it may happen. I think that's unfortunate, but it may come to that. I think the administration is resisting it; they prefer not to go that way for all of the reasons that we're familiar with in terms of the symbolic notion of nationalization of major lending institutions. But I listened to what Alan Greenspan had to say and what others have said and I'm concerned that we may end up having to do that, at least for a short time." (Bloomberg Dodd Says Short-Term Bank Takeovers May Be Needed (Transcript) Feb ...)

Mr. Greenspan left out the subordinate debt holders. Wipe out the subordinated debt and the insurance industry will be bankrupt. "Global issuance of hybrids reached $175 billion in 2007, and roughly $800 billion are outstanding worldwide. Perhaps two-fifths are owned by life insurers. If the banks are seized and their capital wiped (equity plus equity-like hybrid debt), the capital base of the life insurers collapses along with it. The result will be a frantic bout of precautionary saving and more economic free-fall." (David Goldman If the banks go, what happens to insurers?) They are the largest holders of preferred financial stocks. The resulting write downs of preferred and hybrid securities will crush insurers and pension funds.

Clearly the market is worried that the subordinated debt of weaker institutions may be repudiated in bank nationalization. On Wednesday 5-year protection on Citicorp's subordinated debt jumped to LIBOR plus 522 basis points (mid Wednesday), a widening of +80 overnight and +126 basis points in the past week. "Just look at the preferred of some of the banks: Bank of America's J-share 7.25 percent non-cumulative preferred stock is currently yielding 30 percent -- a clear indication that there is concern that preferred could get wiped out, which is what would likely happen in the event of nationalization." (David Goldman it's the insurers, stupid).

In the early 1990s, Sweden and Finland nationalized a large part of their banking systems. Shareholders were wiped out in most cases, but both governments offered a blanket creditor guarantee. Even the subordinated debt was safe. The reason was that a considerable part of the bank debt was provided by foreign creditors, and policy makers in the two countries were concerned about a loss of confidence by foreign investors if they did not protect all bondholders. Norway did not offer a blanket creditor guarantee, but the vast majority of creditors suffered no loss.

Sweden spent about 4% of GDP fixing up its financial system, but then recouped about 2% of GDP when the banks were sold off. (Source: BCA Investment Strategy February 20, 2009)

In short nationalization in Sweden resulted in transfer of wealth from one rich group and the poor tax payers to another rich group.

While some are busy constructing a utopia after bank nationalization, there is a war raging for the restructuring (redistribution) of the power and wealth of the crumbling financial empire, and bank nationalization is the latest battle in that war.


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