Nationalization Will Be Horrific (But the alternative is far worse)

[girl gone mad]

Nationalization Will Be Horrific
John Carney, http://www.businessinsider.com/nationalization-will-be-completely-horrific-2009-2">Clusterstock

We're still pushing ourselves deeper into the zombie zone, with banks propped up on enough capital to keep the executives in perk-laden sinecures but unable to sustain a growing economy. Is there hope that we'll ever get off this path? Each day brings a new voice out calling for us to avoid the path that Japan took, but so far these calls have fallen on deaf ears.

Part of the problem may be that regulators think those calling for the failed financial institutions to be seized don't understand the financial consequences that would follow. So let's push that out of the way and just say: yes, it will be horrific. There will be a huge domino effect from toppling an institution as large as Citi, and the lives of millions of Americans will be made worse.

Meghan McArdle, who is not exactly a socialist eager to see the government take over the banking industry, http://business.theatlantic.com/2009/02/lost.php">runs through the huge costs:

It's easy to blithely say "Why don't they just make the bondholders take a haircut?" Harder when you think about who those bondholders are: insurers. pension funds. the bond component of your 401(k). Financial debt makes up something like a third of the bond market, and the largest holders are pensions and insurers.

The insurers are the biggest problem, because they're just so heavily regulated. They're not allowed to hold risky assets. Convert their bonds to equity and they will be forced to dump that equity at prices that will trend towards zero. Many insurers will see their capital impaired below the regulatory limits, requiring a government bailout.

Pension funds are the next biggest problem. They're already in big trouble because of stock market declines. The bonds are the "safe" portion of their portfolio, the stuff that's supposed ot be akin to ready cash. Convert their bonds to equity--or worse, default--and suddenly they're illiquid and even further underwater.

Nor is the 401(k) problem small. Bond funds are typically held most heavily by the people closest to retirement; they're for income, not capital gains. What is your mother going to do when a third of her mutual fund income gets converted to equity that produces no cash and can't be sold because the insurers have all had to dump their shares on the market at once? Or simply disappears into the land of bankruptcy lawsuits?

We can add to the list. The market for muni bonds will be badly damaged as the pension funds assets get hammered. Corporate borrowing will become terribly painful. Bankruptcies will follow as some companies find it impossible to raise money. The credit crunch of 2008 will seem like pancakes and syrup for breakfast.

But the fact is that the alternative is far worse. We can't afford to underestimate the cost of the half-measures that are leading to zombified banks. The fingers-crossed implicitly guarantees of bank liabilities and phony-baloney asset values, the drip-drip water torture of capital injections, the lies about banks being "well capitalized" threaten to cripple the economy for the foreseeable future.

Here's how McArcle concludes her item on the costs of allowing the banks to fail:

I think what Geithner et. al. fear is that nationalizing or reorganization will put the government on the hook for massive and immediate losses in both the banking system, and the "safe" entities that lent it money. I fear they may be right. But I think the lesson of Japan is that we have to do it anyway. I don't know what form the fix should take. I don't know how painful the fix will be. But I'm pretty sure any fix that makes us recognize the losses, recapitalize the banks, and move on, will be better than two decades of zombie banks and glacial growth.

[RC]

1. The first thing is to replace the incompetent upper management of the failed banks.

If they broke laws, prosecute them. That will also get them out of the way so they will not clog up the recovery.

[wuvuj]

2. How to fix things....???

http://www.hussmanfunds.com/wmc/wmc090217.htm

“Now he won't let go of the shovel, and he can't dig out of the hole.”
– Randy Travis, The Hole

[barb162]

3. Nationalization will be a good thing.

It's the only way to go.