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Thursday, February 19, 2009 11:18 PM

Nationalization Revisited

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Previously I expressed some thoughts on nationalization in The Nationalization Train Has Left The Station. Greg Mankiw suggests wait a minute, this is just nomenclature as the FDIC shuttering banks would itself be nationalization.

Yves Smith at Naked Capitalism discusses this in Greg Mankiw in Favor of Nationalization (and Tries to Clean Up Nomenclature).

One problem I have is that no one is laying out the details of what should happen. Does Mankiw's nationalization equal Roubini's or Greenspan's? Let's explore that question with a look at Mankiw's Nationalization, or Pre-privatization?

If the government is to intervene in a big way to fix the banking system, "nationalization" is the wrong word because it suggests the wrong endgame. If banks are as insolvent as some analysts claim, then the goal should be a massive reorganization of these financial institutions. Some might call it nationalization, but more accurately it would be a type of bankruptcy procedure.

Bankruptcy could become, in effect, a massive bank recapitalization. Essentially, the equity holders are told, "Go away, you have been zeroed out." The debt holders are told, "Congratulations, you are the new equity holders." Suddenly, these financial organizations have a lot more equity capital and not a shred of debt! And all done without a penny of taxpayer money!

I am sure there are a host of legal issues here. The government cannot blithely walk into banks and tell them they are insolvent when the banks are saying (pretending? hoping? praying?) otherwise. But as bank regulators, the feds have more leeway with banks than they would with other types of business enterprise. How much leeway is an issue beyond my ken.
Unfortunately, Mankiw does not offer many details other than suggesting equity holders will be wiped out and bond holders get the assets.

Questions That Need Addressing

1. Are all US government guarantees of bank debt null and void? They should be. At a minimum, taxpayers are currently on the hook for $300 billion of Citigroup's debt and $100 billion of Bank of America's debt.

2. Are we going to end up creating another banks that is "too big to fail" out of this mess?

3. Will stock holders and preferred shareholders both be wiped out?

4. In a normal bankruptcy process one might expect to see significant changes in management. Will the nationalization process allow the clowns who wrecked these banks to stay in control? For how long? Under what capacity? And what person or committee gets to decide those questions?

5. Will the CDS liabilities be wiped out in entirety regardless of consequences? Clearly they should because otherwise taxpayers will be footing the bill. Unless this is spelled out I suspect measures will be taken to protect Goldman or whoever else is on the right side of those CDS and derivative contracts.

6. What kind of bidding process will be put in place and in what timeframe for the assets of the banks? Who decides and why?

When someone says they are in favor of nationalization, those are the questions that are in play that need to be addressed, for starters. There are likely many other questions that I missed. Unless and until those questions are answered, we cannot know to what extent taxpayers are at risk. I would like to see Nouriel Roubini and Greg Mankiw address those questions, otherwise we may be comparing apples to planets. Without answers to those questions,I strongly suspect taxpayers will be left holding the bag.

Mike "Mish" Shedlock
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