Zombie Banks: Nationalization Is The Only Way Out

Original Link: http://www.istockanalyst.com/article/viewarticle/articleid/3049965

By Salman

The calls for nationalization of weak banks has been gaining ground, with former Fed chairman Alan Greenspan and Republican Senator Lindsey Graham suggesting that the banks need to be nationalized, at least temporarily.

Alan Greenspan, long seen as the adherent of free market economics says nationalization of weak banks could be the least bad option left for US policymakers. "It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring,” he said. “I understand that once in a hundred years this is what you do.”

Lindsey Graham echoed Greenspan's sentiment “We should be focusing on what works. We cannot keep pouring good money after bad.” He added, “If nationalization is what works, then we should do it. It doesn’t matter what you call it, but we can’t keep on funding these zombie banks [without gaining public control]. That’s what the Japanese did. In limited circumstances the Swedish model makes sense for the US.”

Meanwhile, Nouriel Roubini, who had accurately predicted the current economic crisis, revisited the nationalization debate. "Of all the options before western economies, ‘government receivership’ of insolvent banks is the best," Roubini says. He says further that his research suggests that the "total losses on loans made by US financial firms and the fall in the market value of the assets they hold (things like mortgage-backed securities) will peak at about $3.6 trillion. US banks and broker dealers are exposed to about half of this figure, or $1.8 trillion; the rest is borne by other financial institutions in the US and abroad. The capital backing the banks’ assets was only $1.4 trillion last fall, leaving the US banking system some $400 million in the hole, or close to zero even after the government and private-sector recapitalization of such banks. Another $1.5 trillion is needed to bring banks’ capital back to pre-crisis level, which is needed to resolve the credit crunch and restore lending to the private sector." He reiterates that the US banking system is "effectively insolvent in the aggregate."

However, the idea of nationalization is that it is being seen as quite 'un-American' and is usually seen as something which is associated with socialism. However, we have seen that the TARP and the method of capital injection have largely failed to address the problem and despite being bailed out twice, banks like Citigroup (NYSE: C) and Bank of America (NYSE: BAC) are still far from stable.

The primary problem with capital injection is that there no control is no government control over the use of taxpayer's money that has been infused, which in turn may lead to misuse or no use at all- as has been the case with TARP.

That the survival of some of the larger financial institution remains uncertain is something which has not remained a secret. Moreover, it is being said that a Sweden styled temporary nationalization would be less costly compared to other method of rescuing the ailing banks.

Roubini says "nationalization may be a more market-friendly solution: it wipes out common and preferred shareholders of clearly insolvent institutions, and possibly unsecured creditors if the insolvency is too large, while providing a fair upside to the taxpayer. It can also resolve the problem of managing banks’ bad assets by reselling most of assets and deposits — with a government guarantee — to new private shareholders after a clean-up of the bad assets. Nationalization also resolves the too-big-too-fail problem of banks that are systemically important, and that thus need to be rescued by the government at a high cost to taxpayers."

Obama’s administration has so far dodged the idea of nationalization of banks. It is being pointed out that Geithner 'stress plan' may further complicate matters by adding to the woes of the US banking system.

Americans are quietly inching towards the idea of temporary nationalizations as there is a general realization that the piecemeal 'Japanese' approach of dealing with the problems of financial system would ultimately lead to our own lost decade. Thus, Obama's team might have to seriously consider nationalization of "technically insolvent" bank in coming days.