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Tuesday, February 24, 2009

"the 'N' word"

Francesco Guerrera, whose utterly tasteless joke above I wish I'd thought of, joins the cavalcade of nerds arguing that nationalization of insolvent banks is not only advisable, but inevitable. Recent days have seen support for this notion from unlikely quarters. "Enough is enough" seems to be the unifying theme...
Barack Obama, US president, will have to draw on his vast oratorical skills to avoid using the N-word but make no mistake: the authorities are going in.


When commentators warn that a failure by the latest US rescue plan would lead to a “Japanisation” of the financial sector, they are missing the point.
It is too late to worry about banks turning into “zombies” – they already are. Crushed under a pile of toxic assets, paralysed by wafer-thin capital cushions and deserted by fearful investors, once-mighty institutions such as Citi and BofA are barely able to perform basic functions such as lending and underwriting.

In his book, Frederic Mishkin described the financial system as the "brain" of the economy. This analogy proved a little too accurate as the collective craniums of finance proceeded to embark on an orgy of hormone-driven excess the human brain is famous for.

The analogy has since broken down, as the brain lies in a persistent vegetative state, much like myself, with the Federal Reserve in the role of life-support system. The financial system cannot even perform the most basic circulatory function, much like a bad analogy. Ben Bernanke is an intravenous drip.

The ultimate cause of the crisis, the toxic securities whose underlying revenue streams have collapsed as people fall behind or default on mortgages, remain on banks' balance sheets. Pricing them has proved impossible but suffice it to say they are substantially below face value. As the real economy deteriorates, separate classes of asset-backed securities linked to car and student loans face the same fate. Banks cannot solve the problem themselves without realizing huge, suicidal losses. The government cant simply keep handing over taxpayer funds forever.

Hence the call for nationalization.

Many of the criticisms of nationalization have smacked of ideology. However, two stand out. The widely-touted Swedish model of bank clean-up, and indeed the takeovers of small failed US banks, ignores the presence of cross-border linkages of huge multinational banks like Citigroup and BofA. The nationalization of Sweden's banks saw nothing remotely comparable in terms of scale and international exposure, since their problems were more or less isolated at home or in the immediate region.

Secondly, and related, is simply the possibility of vast unintended consequences. We already have the Lehman Brothers example, who's failure triggered defaults on credit derivatives which led to the nationalization of AIG within days. Where nationalization ideally attempts to halt the banking crisis in its tracks, the government nevertheless risks igniting a chain of events whereby takeovers merely lead to speculation over who is next, undermining the logic of nationalization in the first place and dragging the government deeper into a financial management job it was already reluctant to do. Such "black swan" scenarios cannot be ruled out.

Tim Geithner's upcoming "stress tests" for US banks are rumored to provide the pretext for nationalization, since they will no doubt tell us what is already known about banks' solvency. Any step toward nationalization then must take these items into consideration.

Though at this point, facing the exact same problems 18 months later, it still seems a risk worth taking.


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