Sunday, March 8, 2009
An Amazingly Disingenuous Piece by Alan Blinder on Bank Nationalization
Before I start shredding "Nationalize? Hey, Not So Fast," by Alan Blinder in the New York Times, let us first go back to the basic problem,, nomenclature. Blinder does not specifically do so in this article, but opponents to nationalization often raise the image of enterprises being expropriated by the state, in other words, healthy (or at least viable) businesses being stolen. We have the reverse here. Instead a transfer of wealth from the private sector to the state, we have the state (as in the taxpayer) propping up businesses and keeping management demonstrated to be incompetent, perhaps corrupt (let us not forget that overcompensation in phony good times is tantamount to looting, and liberal accounting appears to be awfully common) in place. The normal remedy for failed businesses is to let them fail. But we don't do that with banks. The big fear is depositor runs, and if that were to occur on any scale, it would indeed bring the entire system down. Quite a few readers have said something along the lines of: "I'm opposed to nationalization, the banks should be put into receivership." Hate to tell you, they are the same thing. When a bank fails (technically, the relevant regulators, often state level, deem it to be insolvent, and the FDIC rides in) the FDIC does "own" it. The assets and liabilities are in the hands of the FDIC, it determines how to dispose of them. However, its preference is to seize the bank on a Friday and have the deposits and branches in new hands by Monday. The fact of FDIC ownership is thus not apparent to the public. However, when Continental Illinois failed in 1984, it took nearly a decade for it to be sold (I forget the details, but if my recollection is correct, a reader said it was a real garbage barge). The other big, BIG, problem is terrible incentives. Management has nothing to lose by taking risks, and to get out from under the governments' intense oversight and pay caps, its reason to take aggressive risks as great, if not greater, than before. And now there are no shareholders to take the first hit, say by dividend cuts (with stock prices trading at option like levels, anyone who still holds the shares of the big banks is either a punter, not an investor, or very asleep at the switch), and pay and staffing levels already under pressure, the downside of any miscues comes out of the taxpayers' hide. John Kay of the Financial Times, hardly a socialist, put it well: Governments have attempted to impose the first element of nationalisation (ownership) without the second (ultimate control and accountability). But such a separation is neither desirable nor workable for long. The wrangling over Sir Fred Goodwin’s RBS pension is an immediate, if trivial, illustration of problems that arise when the government, in effect, owns an institution but maintains ambiguity about authority. So is the far more substantive issue of who implements lending obligations of publicly supported banks. Vikram Pandit, Citigroup’s chief executive, poses the issue in stark terms. When the US government announced further support last week, he was reported as telling analysts: “We completely remain in day-to-day charge of the company. We are going to run Citi for shareholders.” But if I were a US taxpayer, I would ask why I had provided $45bn (€36bn, £32bn) to a business that was going to be run for shareholders, especially when the current value of outside equity is barely 10 per cent of my own contribution. I can think of no good answer. The US government has not given Citigroup $45bn because it thinks such support is a good financial investment. Most experience shows the situation of struggling banks gets worse much more often than it improves. The US government has given Citigroup $45bn because it fears, rightly, that its collapse would have devastating consequences for the US financial system. The first objective of Citigroup’s management should be to put the bank in a state in which it can operate without government support. The second should be to ensure that the organisation is structured in a way that can never again jeopardise the stability of the world economy. The interests of shareholders must be entirely secondary. So when Mr Pandit says that the government’s injection of capital will not change strategy, operations or governance, I would e-mail my congressman to ask why on earth not, and tell that congressman what changes I did expect. The company should divest or close activities not related to its essential public function. If Citigroup wants to continue to engage in proprietary trading, it should raise capital for the purpose from private sources. No one wants bank managers to be replaced by civil servants. But there are a lot of perfectly competent bank managers out there, even if there are a lot of incompetent bank executives. Willem Buiter, true to form, does not mince words: Like its American and Dutch counterparts, this toxic asset insurance scheme is without redeeming social value: it is inefficient, unfair and expensive to the tax payer. Apart from that it is great. There also are superior alternatives available: full nationalisation and, best of breed, the ‘good bank’ solution. Now let us contrast these pointed and insightful commentary with Blinder's piece: The financial crisis grows weirder by the day. When philosophical conservatives like Alan Greenspan start talking about nationalizing banks, you know you’ve passed into some kind of parallel universe. Why are so many people entertaining an idea that sounds vaguely Marxian? Yves here. Did you catch that? The article is barely underway and we have an ad hominem attack. "Nationalization" is derided before it is even treated seriously. Back to the piece: The answer, I think, is simple. We have some pretty sick banks in America right now, some of which may not be viable in the long run. But putting a giant bank through bankruptcy is unthinkable. (Remember Lehman Brothers?) And continuing the water torture that is keeping zombie banks alive is both expensive and dangerous. So why not just bite the proverbial bullet and nationalize them?.... Yves here. This is sloppy at best. Lehman went bankrupt because (drumroll) it was not a bank, it was an investment bank. Of course, Goldman and Morgan Stanley are merely bank holding companies, the intent of that change was to give them access to special Fed facilities for banks, not to allow them to be subject to FDIC receivership (since they aren't deposiitaries, they wouldn't be). And there is an interesting paper by John Taylor that argues that the consensus reality, that the Lehman failure led to the Sept-October meltdown, is incorrect (yes, I know you were there, but recall all those studies that show that eyewitness testimony is highly unreliable). Back to the piece: Because “nationalization” can mean many things, let’s first clarify what the current debate is about. Don’t think Hugo Chávez or even Clement Attlee. Imagine instead that the government acquires a majority interest in — or perhaps 100 percent of — a bank, wipes out the existing shareholders and installs new managers. Then, sometime later, a healthy bank is sold back into private hands, and we all live happily ever after. At least that’s the idea. Sounds good, you say? And didn’t Sweden pull this off with great success in the early 1990s? Yes, it did, for which the Swedes deserve praise. But this is not Sweden. Let’s think about some of the downsides to nationalizing banks in America. WHERE TO DRAW THE LINE? First and foremost, the Swedish government had to deal with only a handful of banks; we have more than 8,300. Numbers matter, because deciding where to draw the nationalization line isn’t easy. Presumably, no one wants to nationalize all the banks, thousands of which are healthy. But where do you stop, once you start? Yves here. This is intellectually dishonest and patently ridiculous. First, has ANYONE, ANYWHERE, suggested taking out 8300 banks, or a significant portion of them? The 8300 figure badly misrepresents the nature of the problem. The US banking system has become highly concentrated. The top five banks alone account for 45% of the deposits in the US. As mentioned earlier, the US has well established procedures for resolving small bank. Numbers 20 to 8300, maybe even 15 to 8300, is not the problem (yes, if enough hit the wall and we get asset pile-up, the FDIC may have to have son of Resolution Trust Corp. to sell the dodgy assets). The problem is the top banks, and truth be told, Citi and Bank of America. Blinder also ignores the fact that regulators are obligated under the law to shutter wobbly banks. From former bank regulator William Black: Whatever happened to the law (Title 12, Sec. 1831o) mandating that banking regulators take "prompt corrective action" to resolve any troubled bank? The law mandates that the administration place troubled banks, well before they become insolvent, in receivership, appoint competent managers, and restrain senior executive compensation (i.e., no bonuses and no raises may be paid to them). The law does not provide that the taxpayers are to bail out troubled banks. Back to the article: Suppose we nationalized four banks. Bank Five would then find itself at a severe disadvantage in competing for funds with the government-backed quartet. Forced to pay higher interest rates to attract depositors and other creditors, its profitability would suffer. Soon, Bank Five might start looking like a candidate for nationalization, too — followed by Banks Six, Seven and so on. Yves again. That is counterfactual. There is so much demand for FDIC insured CDs that rates are super low right now. The world is awash with funds. And the FDIC is sponsoring bank bonds too (recall the Goldman issue, among others). Back to the Times: THE DOMINO EFFECT As stock traders began to contemplate the nationalization of Banks Five, Six and Seven, their share prices would tank, and short-sellers might consign the companies to an early grave. Yves here. Ahem, the pending stress tests raise the specter of considerable TARP-y dilution in six months; that's enough to pressure stocks. And the role of stock prices is way overblown in the solvency/health issue. They have contributed to a down cycle when an institution is under pressure from the rating agencies to increase its equity levels by selling stock to avoid a downgrade. That was the fix that the monolines and Lehman were in. To the article: THE MANAGEMENT CHALLENGE The Swedes had a relatively simple task. They never had to deal with institutions of the size and complexity of our banking behemoths. Mr. Geithner has emphasized that governments are ill-suited to manage businesses. I’d take the point a step further: Overseeing the management of dozens, or hundreds, or maybe even thousands of nationalized banks is a daunting task. Yves here. Again, the thousands specter is a straw man. And the "government running the banks" is also trumped up issue. Uncle Sam is not about to appoint a faceless bureaucrat to the job. Blinder could have raised a more realistic issue: can the government find, screen, and persuade enough banking talent to take over key roles? As in a private sector turnaround, the overwhelming majority of employees stay in place. Typically, the CEO, most or all of the board, and perhaps a few other top management roles are replaced at the outset. They then ascertain if more changes are needed. The other (bona fide) problematic issue is that the monster banks need to broken up into smaller pieces, if nothing else to make them easier to bring private later and to reduce systemic risk. In fact, it remains unproven if it is even possible to run a huge international bank well. All the incumbents appear to have made a botch of it. That is a very complicated task (but I guarantee McKinsey, Bain, and BCG would fall all over themselves to get the assignment to figure out how accomplish that). Back to Blinder: POLITICAL OBSTACLES The process of nationalization and reprivatization went amazingly well in Sweden partly because it was remarkably free of political interference. Would that happen here? You decide. My bet is no. Yves here, You think we don't have political interference now? TARP recipients are required to participate in the mortgage mod program, for instance, and the Treasury was required to develop procedures to report to the Congressional oversight panel as to how the TARP recipients were using their money (and the only acceptable answer is "to lend"). We are talking at most a difference of degree, and not much of one, I suspect (and is there any evidence that Continental Illinois was subject to unusual pressures when it was in government hands?). Back to the article: THE CONFIDENCE QUESTION Finally, because nationalization runs counter to deeply ingrained American traditions and attitudes, there is a danger that it might undermine rather than bolster confidence. As I said, this is not Sweden. The Treasury, of course, would never use “nationalization” in public; it would invent some nice euphemism. But the commentariat would not be so constrained. Yves here. Has Blinder been on vacation in the Amazon? There is plenty of chatter in the MSM that the process underway is nationalization. Some have argued that the banks are effectively owned now (by virtue of the equity injections). The public is already upset, It is hard to see confidence in banks being any worse with nationzalization (indeed, it might improve). Moreover, he ignores a completely different risk. As the payout to banks continues, with the taxpayer having insufficient control and no upside, and unemployment getting worse, there is a risk of social upheaval. All of that said, there are arguments in favor of nationalization. Or are there? Yves here. Very cheap rhetorical trick. Back again: One is that financial firms are careening off track, thereby costing taxpayers more and more bailout money. (Think A.I.G.) That’s a big concern — and a major reason to seek quick closure. But remember, the government already owns shares in many banks, and supervisors have immense powers to influence banks without owning them. According to a banking adage, “When your regulator asks you to jump, your only question is ‘How high?’” Because the Fed can pretty much dictate to the banks right now, what additional powers would nationalization bring? Yves again. Ahem, the government share purchases were at well above market prices. And any shareholder will tell you, ownership does not necessarily equate to control (rampant principal-agent problems). Blinder's argument is also somewhat contradictory. If regulators have so much power as to push banks around now, then the concern he raised above (re political influence) is already operative, as I suggested. The plus of nationalization is that the goverment will indeed start acting as if it is in control and start moving the banks towards resolution. Right now, there is a lack of will to "own" the problem, and the banks themselves are the very last to sort themselves out. So the current process guarantees the worst of all possible worlds: meddling on politically hot issues, neglect of the tough decisions that need to be made to clean up the banks. Back to the article: Another argument is that banks’ dodgy assets are hard to value, making it impossible to know how much capital they need — and probably very expensive to provide it. True again. But nationalization doesn’t make these problems disappear. Yves here. Utter rubbish. One of the biggest conundrums now is the bad asset problem. Any disposition with the banks as nominally independent parties means the assets need to be valued, and the only price acceptable to the banks is well above market. That means any sale is yet another massive subsidy to the banks with just about zilch odds of taxpayer profit (the public private partnership concept merely enriches a third party, investors, to hide this ugly fact, making the process even more costly). If the government takes over the troubled banks, the valuation problem goes away, It can sell the assets and see what prices they fetch, The initial sales will probably be at terrible prices but more buyers will come forward as trading markets are established and the perceived risk of buying falls. Back to the piece: If the government takes over a bank, the taxpayers tacitly acquire its assets, thereby inheriting all the uncertainties over valuation. And if a bank has negative net worth when it is nationalized, who do you think fills the hole? Yves here. Ahem, it's filling those holes now, yet private shareholders and management can get undeserved upside. And if the powers that be were to do a weekend special and take out all the banks it deemed at risk, at once, it could also renegotiate their bonds (not that the powers that be have the inclination or guts, but Blinder simply brushed past the issue of bondholder cramdowns, which is what OUGHT to be happening. Bonds are risk capital). Back to the article: So, on closer inspection, the best-sounding arguments for nationalization are really arguments for bullet-biting. Worse yet, even talk about nationalization can be harmful if it puts bank stocks under further selling pressure. After all, who wants to own a stock whose value is heading toward zero? Which is why Mr. Bernanke and Mr. Geithner have taken pains to beat down rumors that nationalization is coming. Unfortunately, their denials can never be categorical. If worst really does come to worst, the other options may evaporate, leaving the government no choice but to nationalize some banks. (Think Fannie Mae and Freddie Mac.) But, please, let’s not rush there. Let’s first at least explore what is called the “good bank, bad bank” approach. What’s that? While there are many variants, the basic idea is to break each sick institution into two. The “good bank” gets the good assets, presumably all the deposits and a share of the bank’s remaining capital. As a healthy institution, it can presumably raise fresh capital and go on its merry way as a private company. The “bad bank” inherits the bad assets and the rest of the capital — which, after appropriate markdowns of the assets, will not be enough. So, again, someone must fill the hole. And, realistically, given the mess we’re in, much of that new capital would likely come from the taxpayers. Here’s a prediction: We will get to the good-bank, bad-bank solution sooner or later. Wouldn’t it be nice if it was sooner? Yves again. Dear God, where does he come up with this stuff? How do you make the good bank/bad bank split happen except in a nationalization/takeover scenario? That is the only way it has ever taken place, historically (yes, there were a few private deals in the S&L crisis, but they were Texas banks when a lot of money center banks were still keen to get into Texas on the cheap. The idea of picking up a clean bank at the bottom of the cycle was mighty appealing. And even then, they took quite a while to get done, another fact not commonly advertised, I know because they were peddled to the Japanese, among others). The fact set is not at all germane to a Citi or BofA or any of the big sick banks. If you read the article again, notice the complete lack of any interest in cost or risk to the taxpayer. The tacit assumption is that the public exists to serve the banks, not vice versa.