[lbo-talk] Krugman on zombie banks and the need for overt nationalization

Michael Pollak mpollak at panix.com
Mon Jan 19 00:23:42 PST 2009


http://www.nytimes.com/2009/01/19/opinion/19krugman.html

The New York Times

January 19, 2009

Op-Ed Columnist

Wall Street Voodoo

By PAUL KRUGMAN

Old-fashioned voodoo economics -- the belief in tax-cut magic -- has

been banished from civilized discourse. The supply-side cult has shrunk

to the point that it contains only cranks, charlatans, and Republicans.

But recent news reports suggest that many influential people, including

Federal Reserve officials, bank regulators, and, possibly, members of

the incoming Obama administration, have become devotees of a new kind

of voodoo: the belief that by performing elaborate financial rituals we

can keep dead banks walking.

To explain the issue, let me describe the position of a hypothetical

bank that I'll call Gothamgroup, or Gotham for short.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in

liabilities, so that it has a net worth of $100 billion. But a

substantial fraction of its assets -- say, $400 billion worth -- are

mortgage-backed securities and other toxic waste. If the bank tried to

sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it's still operating, but the reality is

that it has already gone bust. Its stock isn't totally worthless -- it

still has a market capitalization of $20 billion -- but that value is

entirely based on the hope that shareholders will be rescued by a

government bailout.

Why would the government bail Gotham out? Because it plays a central

role in the financial system. When Lehman was allowed to fail,

financial markets froze, and for a few weeks the world economy teetered

on the edge of collapse. Since we don't want a repeat performance,

Gotham has to be kept functioning. But how can that be done?

Well, the government could simply give Gotham a couple of hundred

billion dollars, enough to make it solvent again. But this would, of

course, be a huge gift to Gotham's current shareholders -- and it would

also encourage excessive risk-taking in the future. Still, the

possibility of such a gift is what's now supporting Gotham's stock

price.

A better approach would be to do what the government did with zombie

savings and loans at the end of the 1980s: it seized the defunct banks,

cleaning out the shareholders. Then it transferred their bad assets to

a special institution, the Resolution Trust Corporation; paid off

enough of the banks' debts to make them solvent; and sold the fixed-up

banks to new owners.

The current buzz suggests, however, that policy makers aren't willing

to take either of these approaches. Instead, they're reportedly

gravitating toward a compromise approach: moving toxic waste from

private banks' balance sheets to a publicly owned "bad bank" or

"aggregator bank" that would resemble the Resolution Trust Corporation,

but without seizing the banks first.

Sheila Bair, the chairwoman of the Federal Deposit Insurance

Corporation, recently tried to describe how this would work: "The

aggregator bank would buy the assets at fair value." But what does

"fair value" mean?

In my example, Gothamgroup is insolvent because the alleged $400

billion of toxic waste on its books is actually worth only $200

billion. The only way a government purchase of that toxic waste can

make Gotham solvent again is if the government pays much more than

private buyers are willing to offer.

Now, maybe private buyers aren't willing to pay what toxic waste is

really worth: "We don't have really any rational pricing right now for

some of these asset categories," Ms. Bair says. But should the

government be in the business of declaring that it knows better than

the market what assets are worth? And is it really likely that paying

"fair value," whatever that means, would be enough to make Gotham

solvent again?

What I suspect is that policy makers -- possibly without realizing it

-- are gearing up to attempt a bait-and-switch: a policy that looks

like the cleanup of the savings and loans, but in practice amounts to

making huge gifts to bank shareholders at taxpayer expense, disguised

as "fair value" purchases of toxic assets.

Why go through these contortions? The answer seems to be that

Washington remains deathly afraid of the N-word -- nationalization. The

truth is that Gothamgroup and its sister institutions are already wards

of the state, utterly dependent on taxpayer support; but nobody wants

to recognize that fact and implement the obvious solution: an explicit,

though temporary, government takeover. Hence the popularity of the new

voodoo, which claims, as I said, that elaborate financial rituals can

reanimate dead banks.

Unfortunately, the price of this retreat into superstition may be high.

I hope I'm wrong, but I suspect that taxpayers are about to get another

raw deal -- and that we're about to get another financial rescue plan

that fails to do the job.



More information about the lbo-talk mailing list