Sunday, February 8, 2009

Rather, they say they are committed to the principle that private ownership should be maintained whenever possible.

From the Washington Post:

"A Tricky Third Way: Saving Banks Without Nationalization

By Binyamin Appelbaum and David Cho
Washington Post Staff Writers
Sunday, February 8, 2009; A12

Citigroup still has shareholders, a chief executive and a board of directors, but the New York company's major decisions now are subject to Washington's approval.

The federal government, Citigroup's largest investor, has forced the company to slash its dividend, pursue the sale of units including its Smith Barney retail brokerage and modify mortgage loans according to a government formula. A corporate jet was sold at the urging of federal banking regulators, and the company's chairman was replaced. The bank must issue public reports on its use of government money.

But senior officials in the Obama administration insist that Citigroup has not been nationalized.

Despite calls from some economists and members of Congress, officials say they are determined to maintain the appearance, and in important respects the reality, that banks remain under private ownership. Chastened by the results of the government's September seizure of American International Group, they say that true nationalization would open a Pandora's box, and that they are focused on cheaper and more efficient solutions to the financial crisis.

Treasury Secretary Timothy F. Geithner was scheduled to unveil a new government plan tomorrow to help banks deal with troubled assets. Officials continued to discuss details yesterday.

One thing that's clear: Nationalization is on the table only as a last resort for preventing the collapse of large banks.

"We have a financial system that is run by private shareholders, managed by private institutions, and we'd like to do our best to preserve that system," Geithner told reporters recently.

The word nationalization calls to mind banks owned and run by the government in perpetuity, as with China's largest banks. In Western economies, however, nationalization more often resembles detox. The government takes control, scrubs away problems and returns the company to private ownership.

Countries including the United States have a long history of temporarily nationalizing large, troubled banks. Smaller banks that get into trouble can be absorbed by healthy companies, but the largest banks often can be absorbed only by the government itself.

The most recent domestic example was the July nationalization of IndyMac Bancorp, a California mortgage lender. The company was seized and run by the Federal Deposit Insurance Corp. for about six months before the government sold the company to private owners last month. John Bovenzi, the FDIC's chief operating officer, served as chief executive.

But IndyMac is an example of a company that needed to be seized. The nationalization now envisioned by proponents, including lawmakers and economists, would involve companies that could remain private, at least for now.

The basic problem confronting the government is that banks hold large quantities of assets they consider more valuable than the prices investors are willing to pay. Banks cannot sell the assets without incurring massive losses, but holding the assets is tying up vast amounts of money and inhibiting new lending.

There is widespread agreement among policymakers and economists that the government must deal with the troubled assets, either by buying them or by guaranteeing to limit banks' losses. The price is the problem. If the government buys or insures the assets at market prices, banks may not survive the massive losses. If it agrees to the prices banks consider fair, taxpayers could incur massive losses when the assets eventually are sold.

Nationalizing troubled banks would allow the government to take distressed assets without having to set a price.

The model for such an approach is Sweden, where the collapse of a real estate bubble led the government to take control of two of the country's largest banks, Nordbanken and Gota, in 1992. The government stripped the banks of their bad assets, which it kept in a pair of new companies known as "bad banks." The remnant "good banks" were then merged into a single company and launched back into the marketplace.

"The government is going to own these assets one way or the other because the banking system can't deal with them," said Paul Miller, an analyst at Friedman, Billings, Ramsey who favors temporary nationalization. "You say, management get lost, I'm running the institution, I clean up the institution and I can sell that out to the street, without all of the problems."

Government officials, however, argue that they have a responsibility to pursue the least costly solution, and that they continue to believe smaller steps than nationalization can resolve the crisis.

While some banks have large concentrations of troubled assets, the bulk of the problem is spread across many of the nation's 8,300 banks. Nationalizing enough banks to clean up the problem would be hugely inefficient, officials say. A source familiar with the administration's thinking said he thinks that would make sense only if the economic situation deteriorated massively. And in that dire eventuality, the source said, "The government will end up owning everything anyway."

Officials also are nervous that placing banks under government control would put them within reach of politicians and policymakers with their own agendas. They are concerned that using banks to implement public policies risks compromising their core role as lenders. Countries where banks are nationalized on a permanent basis often direct institutions to make loans that serve public policy purposes without adequate regard for risk or return, which tends to reduce lending capacity in the long term, according to many economists who have studied nationalization.

Some say IndyMac offers a recent example. The FDIC's chairman, Sheila C. Bair, implemented a new kind of program at the company to modify mortgage loans to help homeowners avoid foreclosure. Bair imposed a similar program on Citigroup when the company requested a second round of government assistance. The FDIC argues that the modifications are in the best financial interest of the institutions.

The government's view of nationalization has evolved substantially in recent months. Following the seizure of IndyMac, the government took control of mortgage finance companies Fannie Mae and Freddie Mac in early September, then AIG at the end of the month.

Some senior officials now view AIG as a cautionary tale. The company has been forced to sell valuable business units into a market that is lackluster at best. In addition, AIG has promised nearly a billion dollars in retention pay to employees it says are vital, only to be scolded by lawmakers for wasting taxpayer money. Insurance brokers have become reluctant to push the company's products. The brand has been badly tarnished, reducing the government's ability to return the company to private investors.

When the government started investing $250 billion in banks in November, officials limited the resulting ownership stakes by accepting warrants that could be converted to common stock equaling only 15 percent of the amount invested.

Geithner and top White House economic adviser Lawrence H. Summers have long believed that nationalization is problematic, and the AIG experience reinforced that, according to sources familiar with their thinking. The current administration therefore plans to continue the approach of limiting ownership stakes.

Banks' low share prices make it difficult to invest billions of dollars without acquiring majority control. Citigroup's market value, for example, is just $21 billion, less than a tenth of its market value before the financial crisis. To get around this, the government is preparing to invest money in exchange for convertible bonds -- guarantees of repayment that could be converted into shares of common stock later, according to people familiar with the discussions. That way the government could recapitalize banks but not initially increase its ownership stake in the companies.

The limited ownership stakes have not changed the reality, however, that banks are taking money from the government. And restive politicians on Capitol Hill have made increasingly clear that they expect more than money in return. They want the banks to increase lending and decrease spending on executive salaries and airplanes and dividends for shareholders. And they want banks to prevent home foreclosures by modifying mortgage loans.

The investments also have changed some customers' views of their banks. Irene Sanders, a Washington area resident, is furious that her bank has continued to raise interest rates despite the government's investment. She said she believes banks should be required to explain in detail what it is doing with government money.

"I've been a shareholder in companies, and I get reports, I get information," Sanders said. "In this case, we're all stockholders, but we're not being treated like stockholders."

Citigroup has become a prime target. The government has invested $45 billion in the company, and guaranteed to limit the losses on a $301 billion portfolio of troubled assets. As part of the intervention, government regulators, led by the Federal Reserve Bank of New York, have taken an increasingly active role in the company's affairs, specifying strategic objectives and approving the company's plans to meet those goals, according to people familiar with the matter.

The government also has taken a heavy hand with Bank of America, insisting that the Charlotte company complete a planned deal for the troubled investment bank Merrill Lynch despite an unexpected spike in that company's losses. Bank of America has received $45 billion in government assistance, plus a guarantee to limit losses on a portfolio of $118 billion in troubled loans. Still, the government controls less than 10 percent of the shares in each company. The decision to intervene without taking majority control has greatly benefited the companies' shareholders, but officials insist that was beside the point.

Rather, they say they are committed to the principle that private ownership should be maintained whenever possible."

Me:

"Government officials, however, argue that they have a responsibility to pursue the least costly solution, and that they continue to believe smaller steps than nationalization can resolve the crisis."

The idea, that a hybrid plan, in which the government and banks pursue different agendas, the management teams of banks who are causing a systemic crisis are left in place, and in which the banks continue to successfully lobby, is the least costly solution defies belief. The moral for banks will be that we can cause a depression and politicians will still support our interests at the expense of the taxpayers. Sweden only needed to fully take over a few banks. Moral hazard dictates taking over a few banks because that's what banks really fear. In fact, in the face of nationalization, they actually hoard money. Wow. By the way, according to Liddy in November, the whole point of the money from the government was for a bridge loan to keep from selling "assets" at fire sale prices. If they're doing that, this really has been a farce. The Pandora's Box was opened by the banks and their feeling that lobbying had bought them insurance from the government to keep them from blowing up come what may. So far they're being proven right. The only way to close the box and put a foot on it to keep it closed it to nationalize some banks. Sadly, Willem Buiter is correct:

The trio of Ben Bernanke, Geithner and Summers are likely to produce a veritable moral hazard monsoon.

I hope we enjoy monsoons.

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