Saturday, February 21, 2009

Bank holding companies vs banks

With regard to the need for nationalization, there really is no difference unlike Tyler Cowen's statements:

Thinking through the implications of said nationalization for the counterparty positions of a bank holding company, or its role in the commercial paper market, is mind-boggling. Neither the FDIC (which generally does an OK job) nor any other government agency is in any way prepared for this kind of management task. It has very little to do with standard FDIC procedures. All I hear about is "bank" this, "bank" that, etc. but again little or no talk of the bank holding company.

Of course this is only a problem for the five or six biggest financial institutions but those are precisely the issue at hand.

I usually don't like to speak so negatively, but it's the advocates of nationalization who are in denial. There is a belief that Obama, Bernanke, and/or Geithner are somehow spineless or in the pocket of the banking lobby. The sadder truth is that they understand just how ill-prepared the U.S. government, or the Fed, would be to run such an enterprise.

I do understand that if all the water runs out of the sink, as it may, nationalization will come in some form or another, however disastrous that may be. But the desire to postpone it until the last possible moment, and the desire to pursue even a small chance of avoiding nationalization, are signs of wisdom, not cowardice.

Of course this is only a problem for the five or six biggest financial institutions but those are precisely the issue at hand.

It is precisely because of these five or six financial institutions that nationalization is necessary. By the time all the water runs out of the sink and nationalization is inevitable the Treasury or Fed would have lost valuable time learning about running bank holding companies that they could have done so earlier. In any case this is the sign why postponing the inevitable will inevitably lead to a longer recession of probably in the five to ten year range.

It is also unclear whether the opinion that the Fed is ill prepared is a statement about competency of the Fed to run the an organization/company or because it doesn't really know the markets and products of the bank holding companies well. If it is the former then that can be overcome but if it is the latter then it means that financial innovations are always going to be ahead of regulators and they will never have any hope of learning how to regulate new products.

Moreover, by postponing nationalization, the authorities are losing the opportunity to bring a shadow market into regulation and decreasing uncertainty:

....The enormous amount of derivatives that had poured into the market—there are close to $600 trillion of these papers around—are also not recorded in a global or centralized manner, or in a manner that allows you to begin to quantify them. [Former SEC Chairman Christopher] Cox thought that maybe the toxic part of all of these assets was $1 trillion to $2 trillion. [Treasury Secretary Timothy] Geithner told us there's maybe $3 trillion or $4 trillion. Nobody really knows, so in a way [they've created an] informal or shadow economy. This unidentified paper is the source of uncertainty and the credit contraction.

(Interview with Hernando de Soto. HT: MR)

Meanwhile other speculations on nationalization:
From Salon: The Obama administration has contributed to that uncertainty by stressing in public an opposition to "nationalization" but failing to deliver any specificity on how it intends to proceed otherwise. Ironically, it's possible that the Obama brain trust may have decided explicitly to downplay the likelihood of nationalization, under the assumption that such rhetoric would spook the markets even further. That doesn't necessarily mean Obama, Larry Summers, and Tim Geithner are pawns of Wall Street. It could just be that they made a strategic decision to speak softly before making an intervention, rather than signaling their intentions and risking an even higher level of chaos. It's OK for Alan Greenspan to start talking positively about nationalization; each and every utterance by the Maestro no longer moves the markets like an electric shock. But if Bernanke or Geithner or Obama say the word, people will jump.

Whether or not such a strategy was in place is moot now. Investors are convinced some kind of intervention is inevitable. So they're dumping bank stocks, which further weakens the financial positions of the big banks and thereby virtually ensures that intervention is required. Fear of nationalization begets nationalization.

Which is all the more reason why it needs to happen quickly instead of piecemeal. Cries of fairness will eventually result as those who bailed out early prior to nationalization get to recoup some losses.

Jim Hamilton discusses the mechanics valuing toxic assets. He says that a debt for equity swap could be potentially destabilizing although does not discuss how -- the current volatility in bank stocks would be one perhaps but this is all the more reason why nationalization has to happen quickly if at all. His conclusion is shared by many:

What we need is not a painless resolution of the crisis, but rather a plan that puts the pain behind us.

Update: The Case For and Against Nationalization by Matthew Richardson is a very even handed discussion. Acknowledging the problems of the government running a large complex financial institution does not necessarily preclude the idea that nationalization may be the best option currently.

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