Saturday, April 18, 2009

Swedish Model to Kill Off Zombie Banks

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By Miles Mogulescu

No, it's not a classified ad from a porno magazine. The Swedish Model I'm referring to is not a beautiful blond with long legs who entertains overpaid bankers at a plush resort retreat paid for by the taxpayers. And the Zombie Banks are not characters from a George Romero movie.

The Swedish Model is the financial plan by the Swedish government to successfully rescue its country from a financial meltdown in the early '90s under which several of its largest private banks were nationalized, recapitalized and reorganized, and then sold back to new private shareholders. The Zombie Banks are banks like Citibank and Bank of America which are functionally bankrupt but continue to walk around like the living dead because they have received blood transfusions of TARP funds which exceed their market value and not been forced by government regulators to account for their true financial liabilities.

A broad consensus on both the right and the left seems to be emerging in support of nationalizing Zombie Banks as quickly as possible before they can eat up more banks, creating more Zombies, and bringing on an even bigger and longer-running financial disaster. Republicans Senators like Lindsey Graham and even John McCain say nationalization should be on the table. After initially rejecting it, Democratic Senators like Chuck Schumer and Chris Dodd are coming to accept it. Mr. Free Market Fundamentalist himself, Alan Greenspan has suggested it. Liberal economists like Nobel Prize winners in Economics Joseph Stiglitz and Paul Krugman strongly support it. Conservative economists like Adam Posen of the free market-oriented Peterson Institute support it, too. NYU Business School professor Nouriel Roubini, known as "Dr. Doom for being one of the first to predict the financial meltdown, has written an Op-Ed column in the Washington Post advocating it. Even current Fed Chairman Ben Bernanke seemed to acknowledge on Wednesday that nationalization of some Zombie Banks may be all but inevitable and simply cautioned that they should be re-privatized as quickly as possible.

It seems that only Wall Street bankers themselves, along with Barack Obama and his top economic advisors, Tim Geithner and Larry Summers, continue to voice support for keeping Zombie Banks on taxpayer-subsidized life support. Obama Press Secretary Robert Gibbs said Friday that the Obama administration continues to "strongly believe that a privately held banking system is the correct way to go." The Washington Post reported that Geithner and Summers "think governments make poor bank managers". They must think that their mentor, Clinton Treasury Rob Rubin--who made more than $110 million (not counting stock options) before stepping down last month, and who urged Citibank to take greater risk in the subprime mortgage market in order to increase its profits--is the model of a good bank manager. At the moment, Geithner, Summers and Obama look a bit like the lead characters in "Weekend at Bernies", hauling around a corpse hoping no one notices it's dead.

If Obama wants to have a successful Presidency and prevent the present recession from turning into a 1930s style depression, he would be better served to stop taking advice from long-time Wall Street servants like Geithner and Summers and start studying the contrasting approaches to Japan and Sweden to their respective financial crises in the '90s. Japan acted slowly, followed an approach much like Paulson's and Geithner's, and experienced what has been termed a "lost decade" of economic stagnation. Sweden acted quickly to take over its Zombie Banks and returned to financial health relatively quickly, while returning a significant portion of the government's investment to the taxpayers.

With a bipartisan consensus for temporary nationalization emerging, including conservative Republicans Senators like Graham and McCain and centrist Democratic Senators like Schumer and Dodd, Obama should stop dragging his feet and get out in front of the parade carrying a big sign reading, in Prof. Roubini's words, "We're All Swedes, Now."

No, actually I take that back. In order not to spook markets, Obama and a small team of financial commandos needs to orchestrate a sneak attack on the Zombie Banks. If it's not done in one feel swoop, capital will flee non-Zombie banks, turning them into Zombies, too and aggravating the problem.

Speed is essential, but Obama and company need to get all of their ducks in row first: Quickly stress test the 6-10 largest banks, determine which are truly insolvent and must be nationalized and which have the ability to continue as going concerns with a little help. (Maybe Citibank and B of A get nationalized, while JP Morgan Chase and Wells Fargo remain in private hands.) Hold top secret bipartisan meetings with key Republicans and Democrats in Congress, including Graham, McCain, Schumer, Dodd and Frank to insure that when the plan is announced there will be some political cover from important conservative Republicans. Organize a media roll-out, which includes supportive statements from key Republicans, to sell the plan to the public. Then Obama announces a televised prime time address which he uses as a teaching moment, employing his formidable rhetorical and analytical skills (much as he did in his Reverend Wright speech) to give the American people a nuanced explanation of both the depth of the financial crisis and the reasons why temporarily nationalizing a handful of the largest banks, using something akin to the Swedish model, is the best way to solve the crisis and assure that vital credit keeps flowing to businesses and consumers--And announces which banks are being taken over and which banks will not be taken over. The shareholders of the banks being nationalized will be wiped out, but those of the other banks will be reassured, thus preventing a "run on the bank."

Anyway, that's how I hope it works. If Obama, Geithner, Summers and Sheila Baer can engineer such a strategy, perhaps the financial crisis can be resolved and the economy will recover within a few years. If they persist in defending a purely private banking system combined with a private/public hybrid aggregator bank--whether because they truly believe American cultural values will reject anything else or because they are too close to Wall Street bankers to consider wiping them out--there's a serious danger that the recession will turn into a depression and Obama's presidency will be a failure.

It's time for audacity...and a Swedish Model.

UPDATE: The Wall Street Journal is reporting that Citibank is offering the Federal government a 25%-40% ownership stake in the bank. While few details are reported, this looks like a very bad deal for the taxpayers and a windfall for Citibank shareholders and management. The Federal government has already injected $45 billion of capital into Citibank and guaranteed Citibank against over $300 billion in losses on some of its toxic assets, while Citibank's market value is less than $20 billion. If Warren Buffet did the same, he would end up owning Citibank several times over and would receive the upside when assets are sold off. The taxpayers should be treated no worse.

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