I Was Wrong On Bank Nationalization

(noon. – promoted by ek hornbeck)

No one likes to admit that they were wrong. This seems doubly true on here on the great inter-toobs, but the fact is that the Dog was wrong. It is only in one case (at least he is only going to cop to one case right now!) but it is a pretty major issue that we face right now. What is this issue? It is the case for nationalizing failing Banks. When this was first discussed, the Dog perhaps like a lot of others, assumed that we were talking about a complete and total take over of the banking system by the Federal Government. That would be something akin to the Venezuelan government taking over their oil industry.  

Over time it is has become clear there was a problem with operational definitions, where most (though not all) of the folks advocating for nationalization of banks were talking more along the lines of what happened in Argentina, where a government (usually with World Bank prompting) steps in and takes over their failing banks, puts in new management, cleans up the problems and then sells them to some new set of investors. After looking into things a little (the Dog is not an economist by trade so this required research and some thought) it becomes clear that this is a very reasonable and perhaps required step for any nation facing a bank insolvency crisis like we are.

So, the Dog has to say that he was wrong, there is a need to nationalize failing banks, but that does not make it an easy prospect. Because of the way that these banks have become insolvent this crisis is nearly unimaginably huge.  One of the best places to get a good, plain language description of what is going on and how we got here is NPR’s Planet Money. You can find it at this link. We all know (or think we know) that a major cause of this crisis is the toxic mortgage assets that were sold as investments.

There are two factors that have made this situation so bad. First off when a homeowner defaults on a loan, the bank is now on the hook for the money they loaned for that home. When they made the loan, they expected to make money on the loan itself in the form of interest. Once they foreclosed on the house, they would have an asset that they could sell. If they can sell it for enough they do not have to use any of their capital to cover the losses. This only becomes a problem when there are tens of thousands or millions of home loans that are going bad. Then even a small loss of capital can be critical, as it gets multiplied by the number of loans you have to cover your losses on.

This is where the other factor comes into play. The value of residential homes has fallen every month for the last 35 months in a row. This means that when a bank forecloses on a loan now, they are not going to loose just some money if they can sell it, they are going to lose a lot of money as the value of homes has fallen from 5% to 50% depending on where the home is. Now multiply that by the huge number of homes in default or foreclosure and these banks are looking at, in some cases, more losses than they have in assets. This is what makes them insolvent. Even if they could sell the foreclosed homes (which is doubtful right now) the prices that they could get for them is not enough to keep them from wiping out the deposits and other assets they have. Basically their balance sheets do not balance, at all.

For about the last 6 months Bankers have been making this argument that since there is no one that would want to buy these toxic assets, they do not have a market price. This is important as there is a concept in accounting called mark to market. This is the idea that if an asset you have like a house or a mortgage looses value, you should mark it down to that new value. This is what makes the balance sheet actually balance. The thing is that the Bankers don’t want to do this, as it would show that they are actually insolvent and would have to close their doors. Their argument is that since there is no known price for these toxic assets and they are sure to go up in the future they should not have to take this loss on their books at this time.

The problem here is that there is no end in sight for home prices. To make the situation worse, the very uncertainty of the value of banks is causing on going problems in the credit markets and the greater economy. This allows home prices, which are based on what people will and can actually pay for them continue to fall. There is no solution for this that allows the banks to continue to pretend that there will be sunshine tomorrow, as some of the biggest banks in the nation are already insolvent if they are forced to mark to market.

So, it becomes pretty clear that we can not play “hide-the-loss” for the four or five years it will take for the home prices to have a chance to rebound. That way lays a wasteland of economic ruin. At the same time nationalizing the banks is not going to be easy, cheap or without cost to the people of our country. If we use this mark to market calculation, there are potentially 1,000 banks in the US that would need to be nationalized, cleaned up and sold. That is a hell of a lot of work and a hell of a lot of value that is going to be wiped out. But it looks as though it has to be done. We have to get our economy on a more stable footing and we can not afford to vaporize more money by pouring it into a bottomless pit.

The Obama Administration has a plan that they have announced that they will follow. They are going to “stress test” banks to in an effort to see which are really going to fail and which might (if we all believe clap really hard like saving Tinkerbelle) survive without nationalization. They then intend to take some time to develop a plan to address this, all the while keeping banks afloat with bail out money.

Many in this country hate this idea, but the Dog has a thought about it. President Obama is a master of the political head fake. He is very good at letting folks that would resist him get comfortable that they know where he is going, then he springs a direction change on them that leaves them stunned and him in the position to do what he thinks is the right thing. The Dog could be wrong (which is the premise of this diary) but it seems like the Administration is setting up just this kind of head fake. They have the data to know that these banks are already insolvent. They know that that taking them over will be a big step, but if it can be achieved as fait complete then they don’t have to hang on to them for very long. So, the Dog thinks that some time in the next 3 months or so, on a Friday night, we will hear that the FDIC and the Federal Reserve in concert with the Obama Administration has nationalized 800 or so banks. By that following Monday, the plan which is already in place will be moving forward.

That is the Dog’s prediction, what is yours?

You have the floor