20 February 2009

Love it or hate it, bank nationalization is inevitable

All the gnashing of teeth of a possible bank nationalization misses the real point- it is inevitable, regardless of whether anyone wants to do it or not. The major US banks (like Citigroup and Bank of America) are technically insolvent, and unless some miracle occurs that turns their non-performing loans back into gold then these institutions are doomed.

Sure, it’s theoretically possible that the government would just stand by and allow a Citigroup to keel over, and wind up being liquidated in a bankruptcy, but policy makers would never allow such a disorderly crash. Show me just one congressman (other than Ron Paul) who would be willing to allow all the depositors in Wells Fargo to lose their savings?

Instead, the government will be forced to step in and supervise an orderly dissolution, much as what occurs with FDIC conservatorships. I find it strange to hear so many critics about nationalization when nary a complaint is uttered when the FDIC seizes lenders and proceeds to find buyers, and disposal of assets. That’s all we’re talking about here. The only difference is that the big banks are of an order of scale larger than anything the FDIC has hitherto dealt with, potentially saddling the government with enormous liabilities as they pick up the pieces.

Of course, I personally favour the hands-off approach, allowing depositors to be completely wiped out (this would definitely stop any moral hazard in its tracks, when everyone realizes they have to take personal responsibility for putting their money in safe institutions), but I know it will never happen.

Sooner or later the federal government will be forced, kicking and screaming, to seize the nation’s big banks. I am sure this is not what Messr Geithner would like to do, but he won’t have any choice. Unfortunately, judging by the collapse in bank share prices it looks like this will happen sooner than later. As we’ve already seen in many other bank failures over the last year, depositors start to withdraw their money when their bank’s stocks are in the sub $5 range, which creates a dynamic that drives the institution into the ground.

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