I've always been a supporter of the nationalization solution, which is not hard to do on this list. But I have a serious question that I barely see addressed anywhere, so I want to raise it as a devil's advocate.
In general, the argument for nationalization of banks like Citi and BofA seems to rest on the premise that this banking crisis is like all other banking crises, and these banks are like all other banks. They both seem reasonable premises.
On the first, Reinert and Rogoff have studied systemic banking crises going back to 1929 (and banking crises in general going back to the Napoleonic wars), and the clear upshot is that there is small repertoire of responses, and nationalization clearly works the best. It takes the least time and it costs the least money, both to the government's fiscal position, because it recoups the most; and to the population as a whole, and because its speed minimizes the time and amount the economy spends wallowing below trend. Their most recent study further suggests that all other responses are usually attempts to avoid this one.
On the second point, and specifically with reference to America, the argument is that the FDIC nationalizes banks every week, and this will simply be one more. They'll do it the same way they've always done it, and it will work the same way it's always worked. This is not rocket science and we're not inventing something new.
Now here's my question: what if these banks are fundamentally different than all other banks that have been nationalized in the past?
That wouldn't necessarily make nationalization wrong. But it would make it a big leap in the dark -- that could have huge intended effects (and these days in finance, those usually aren't good) -- rather than just doing what we've always done. It might well be rocket science and involve the invention of something new. And thus it might be something to reasonably hesitate before, rather than assert as the obvious immediate solution, with all searching for alternatives preemptively condemned as classic and disastrous procrastination.
Here's my case -- and I'll be happy for people to refute it. My frustration is that I haven't seen this point seriously engaged or even raised much, so I haven't seen anybody refute it, and I'd feel much better if they would.
The first two premises above -- this is the same solution that's been done a hundred times and always worked then; and the FDIC does this all the time -- are being repeated like mantras by the smartest economists I know.
In fact, the first time I remember seeing serious reservations entertained by a stalwart supporter of nationalization is three days ago Sunday on Yves Klein's blog Naked Capitalism:
http://www.nakedcapitalism.com/2009/02/more-on-big-bank-endgames.html
http://www.nakedcapitalism.com/2009/02/more-on-that-dirty-word-nationalization.html
If people know of other places where these points have been discussed, please post the URLs; I'm eager to see them.
So on to the case. Why are these banks not like all other banks? And why might this nationalization be fundamentally unlike all other nationalizations?
1) They're investment banks. At least huge chunks of them are. Am I wrong in thinking that that's extremely rare, almost non-existent, among the previous banks surveyed by Reinart and Rogoff? And more to the point, am I right in thinking that the FDIC specifically has never nationalized an investment bank? In which case, it doesn't have a time-tested template to apply.
And not only are these investment banks, with huge trading operations, they are also broker dealers -- in fact, one of them now contains the biggest primary dealer in the United States. Again, perhaps that's something you can nationalize. But it's certainly not something the FDIC has ever done before. They don't even regulate broker-dealers. The SEC does.
This brings us to the nub of the problem. The FDIC template is the template of receivership, wherein a bankrupt company, in this case a bank, stops doing everything non-essential while the auditors go through the books.
But with trading desks, IIUC, that's not really possible. To put it crudely, an investment bank is more like a flow than a stock. Huge revenues come in, and losses go out, and the difference is what the bank is worth. If you freeze the trading operations, it all melts down almost instantly, because you can't unwind your positions.
Now I think many of us in the nationalization camp think Hey, what does nationalization have to do with bankruptcy? If nationalization comes with a huge infusion of government funds, these firms won't be insolvent. Rather, arguably it'll be the first time they'll be solvent in months. Arguably the only reason people are treating them as solvent now is that they are depending on the implicit promise that the USG won't let them go under. So why should they be spooked if that promise becomes explicit?
In short, why should the USG becoming the owner be any different than Warren Buffett becoming the owner? Why can't 99% of the employees in the bank keep on doing exactly what they're doing the day after nationalization while the auditors examine the books?
That seems reasonable. But if you make that point, you have to give up the idea that this is what the FDIC normally does. Because this is not what the FDIC normally does. It might be what happened in some other countries on the Reinert and Rogoff list, countries which have a long tradition of large respectable state-run banks and firms. But in the US, we haven't got anything ready to roll out. We haven't got the plan on the shelf, we haven't got the personnel standing ready who know their role. I can conceive of being able to organize a pretty good pick-up team out of the large overlap of banking employees and the Fed, and drawing on the big pool of banking employees that are readily available, and private sector investment bigwigs willing to go into public service. And I can conceive of smart people setting up a plan.
But to repeat the original point: all of that is to accept that there is no plan, and that this isn't like all previous FDIC nationalizations. At the very least, more prep would be necessary.
Perhaps one path to that would continuing down what we seem to be doing already, which partial and gradual nationalization. That might be the simplest path toward organizing a fundamentally new form of takeover. Maybe that's why we're doing it that way?
2) Size. As Klein points out above, at the height of the S&L crisis, the FDIC had 20,000 employees. It now has 5,000 employees, and the receivership section has fallen disproportionally more. Meanwhile the size of the banks has gone the other direction. Citi is 30 times larger than Continental. Now, it doesn't take any more time to check the math on billions than it does on millions. But my impression is this isn't simply an adding of zeroes in the amounts they handle, but rather reflects a broad expansion in the size and variety of the operations. And in brute terms, we've got a less people to go through it than we had before. So even if they knew exactly what they were doing, it would take them a lot longer.
3) Complexity. This brings to the next question, "even if they knew exactly what they were doing." This is not a knock on the FDIC. It's simply a statement of fact that much of what these banks do have nothing to do with the FDIC. They not only haven't managed these activities in receivership, they don't regulate them in normal times. As noted, it's the SEC who regulates broker dealers; the CFTC regulates commodity trading; and the OTC and derivatives businesses have been mostly not regulated by anybody. So even if the FDIC sends in their best people, it is likely that not one of them will have any professional experience of any of the fields they are supposed to audit and oversee.
And we haven't even touched on the complexity of the instruments themselves -- the CDOs, the CDS, etc. According to Nomi Prins, many CEOs don't know how these things really work at the auditing level. She suggested on Doug's show that even Hank Paulsen didn't understand a lot of it.
I supposed that be comforting in a way; you might think Hey, that means the FDIC obviously doesn't need to know everything to keep the bank running. But if the whole point is the separate the good assets from the bad, we're back to the idea that this nationalization might be different than all other previous ones, and the FDIC might night have any of the relevant expertise. It might all need to be organized for the first time in history. And even when we are organized, it could take an extraodinarily long time to sort out, judging by the Lehman bankrtupcy. Which might put the bank and it's national owner in a vulnerable position in quick-breaking financial environment.
4) Global reach. Much of these banks' security business is regulated by other countries. And they have large overseas operations. Besides adding to the expertise problem, this adds to the unintended effects problem -- what if something you do makes depositors or creditors or investors overseas feel fucked, like happened in the Iceland/UK dispute? What if a non-US regulator takes their side?
Which brings us finally to
5) The possibilities of meltdowns. There seem to be many more possiblities for same in a huge global investment bank that handles exotic instruments than there are any other bank that has ever been nationalized before. Bear and Lehman melted down almost instantly. There's no reason that has to happen when an investment bank is nationalized. But of course, there's no guarantee it won't either. And that's the key difference between investment banks and commercial/consumer banks. Normal banks don't melt down like that. If you shut the doors, they stop melting. With an investment bank, it's when you shut the doors that they melt. Or more like vaporize. And if it were to start in the future at any as now unforeseen trigger, I don't see any obvious way we could stop it.
And then there are lesser meltdowns, the chances of losing all the key employees who make lots of money for the bank. Normally people who are for nationalization don't care about this, they say good riddance, and scoff at the idea that top bankers and traders can just leave and get work elsewhere when the whole investment sector is contracting and laying off people left and right. But IIUC, hundreds of the key employees of Merrill have already left simply because a commerical bank owned them, never mind the government. And the reason this matters is again because investment banks are more of a flow. If the revenues stop coming in, the value of the bank -- which in a fully nationalized case, we the people own -- starts plummeting.
Conversely, if you just let them trade like they trade, it can go just as bad. Some people argue Merrill's $15B fourth quarter loss came from a single kind of twisty "negative basis" trade that nobody had thought to stop. So you can't trust them understand how things have changed. But you can't trust us to figure it out very quickly either.
Conclusion
There seems a reasonable case to be made that nationalizing these banks isn't a case of doing what we've always done, but rather of stepping into the unknown, with all the scary implications that always contains. And the idea that "the FDIC does this every week" or "lots of countries have done this" doesn't seem to address this. In fact, both of those mantras seem more wrong than right.
Is there a reason why all these fears of mine are baseless? Are there obvious answers to my questions? Are there precedents I don't know? Because I'd feel much better if I had them. And perhaps if these solutions are simple and obvious it would answer my other question, which is: Why haven't these questions been raised at all in the public debate over nationalization? Even opponents of nationalization don't seem to bring this up except in the vaguest possible terms.
Needless to say, if there is something to these fears, it would cast a different light on the hesitance and slowness of the authorities' move towards it.
Michael