Here’s an idea: nationalise the banks

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Suggestions to organise a massive bailout of the banks are being floated by central bankers this week-end:


Central banks float rescue ideas

Central banks on both sides of the Atlantic are actively engaged in discussions about the feasibility of mass purchases of mortgage-backed securities as a possible solution to the credit crisis.

Such a move would involve the use of public funds to shore up the market in a key financial instrument and restore confidence by ending the current vicious circle of forced sales, falling prices and weakening balance sheets.

There are more details in that article (including about disagreements between the Fed and the ECB on when the package should be put in place), but two things stand out:

1) the financial crisis is now acknowledged as bad enough to require public intervention;

2) that intervention will require significant injection of public money in bank’s balance sheets.

As we have seen with the last minute bailout of Bear Stearns, both have happened, with the Fed being actively involved in the negotiations over the purchase of BS, and ending up providing $30 billion of guarantees to JPMorgan, to cover potential BS liabilities.

Thus we have a solution which has the following consequences:

1) Bear Stearns shareholders are largely wiped out. This is as it should be;

2) JPMorgan gets the good bits of BS for free; if the BS assets it picked up are bad, it is largely protected from losses by the Fed, but if they are less bas as feared, it gets all the upside. This is a great deal for them;

3) the Fed provides a guarantee which gives it no benefit in any case (beyond saving other banks from BS’s meltdown), but may end up costing it up to $30 billion. Not a great deal.

Now, I was much intrigued by a recent opinion piece in the Financial times, which suggested a pretty sensible solution to the current crisis: Ask the oil producers to rescue Wall Street. The idea is that banks need to be recapitalised, to fill the gaps created by recent losses, and to help rebuild trust. Banks are not lending to one another because of worries about the state of the balance sheet of other banks and are increasingly not lending to the economy because they no longer have anough capital and/or are hoarding cash not to be caught short in the near future. Recapitalising them would help solve both the liquidity and the trust issues. And the authors suggest that the logical entities to do such recapitalisation would be the Sovereign Wealth Funds (SWFs) from oil-exporting (and dollar-rich) countries. It has already happened on a small scale at the end of last year, and the authors suggest that it take place on a larger scale, with an appropriate discount.

in a sense, this is fair. To a large extent, the US has been living on credit from exporting countries, and one of the items bought on credit that way on the largest scale is oil. Now that this credit is shown to be failing, it is only appropriate to pay up using what passes for real assets in today’s economies: corporations, and in particular the sector at the heart of the credit machine: banks.

Paying for oil with banks – what an oddly fitting movement that would be.

:: ::

But if you put together the large amounts of our money that central banks seem willing to put on the table to save the financial system, and the idea outlined above, the solution is obvious:

use central bank money directly to get equity in banks

Why should the central banks only provide debt to struggling credit institutions? They should grab the equity, and ensure that they get an upside if the situation somehow improves.

There was no reason whatsoever to make that $30 billion guarantee free to JPMorgan shareholders. It should have been traded for an option on an appropriate share of JPMorgan capital should things go wrong. Similarly, any new injection of funds in the financial markets should now take the form of equity or convertible loans, rather than be backed only be the worst collateral that the banks can find to dump on the hapless central banks, as seems to be the idea now.

The banks fucked up. If they want help, then they have to give up claims on future profits.

Buy-outs, not bailouts.

21 comments

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  1. Happy Easter to all of you!

  2. Make the banks live by the same rules they impose when they are creditors. It might also be a good idea to decentralize the control over the central banks, so that their decisions are more in the public control.

  3. It would be really great to pass along the message that plundering the US for private gain isn’t acceptable any more and that from here on out to receive monetary rescues banks (and other potential bailout companies) have to give equity.

    Also, as things stand now, the shareholders are justifiably screwed, but the management and whatever remains of the entity seem to be getting a free pass.  I think, in addition, to receiving equity, the central bank lenders need to be able to freeze and/or recoup executive compensation packages when a bailout/buy out is being offered.  Those funds need to stay in the entity and not be carted off by bad managers.  

  4. The idea is that banks need to be recapitalised, to fill the gaps created by recent losses, and to help rebuild trust. Banks are not lending to one another because of worries about the state of the balance sheet of other banks and are increasingly not lending to the economy because they no longer have anough capital and/or are hoarding cash not to be caught short in the near future. Recapitalising them would help solve both the liquidity and the trust issues.

    I know this may sound like a stupid question but why not charter a new bank?  Instead of buying up all that bad debt with billions of taxpayer dollars, simply capitalize a new financial institution whose bylaws commit it to stringent best banking practices.

    This way you start with a fresh balance sheet unencumbered by all that sketchy paper that has created so much distrust, while letting the old boys who got us into this mess take the market-based medicine they so richly deserve.

    After all, its not really a liquidity problem (there is still plenty of cash sloshing around out there), as much as a trust issue that lenders aren’t lending good money after bad.  

    A new, clean lending institution solves this problem while still allowing the desperately needed shakeout the banking industry must have to reestablish its tarnished credibility.

    Just a thought.

    • Mu on March 24, 2008 at 5:00 am

    But government can’t do anything right!  And governments should be run like businesses (you know, like Enron, like WorldCom, like Arthur Anderson, like Bear Stearns, . . .); businesses shouldn’t be run like governments — they should just get bailed-out by governments when their short-sighted greed causes them to throw the country into economic turmoil, or, what’s even better, they should thrive under the largesse, the munificence of friends in government, like Halliburton, ExxonMobil or Blackwater.

    Is any of this gettin’ through to y’all?

    Mu . . .

    • dkmich on March 24, 2008 at 10:54 am

    They always want to nationalize the risk and privatize the profits.  To do anything any different would be regulating the markets, and lord knows they can spend our money better than we can.  

  5. I have read a lot of articles/op ed pieces coining this phrase over the weekend. I have to say it is the first time all of the pieces seem to fit together for me.

    The phrase boils down to a virtual banking world where new debt instruments were created, bought, swaped or traded based upon formulas generated by increasingly sophisticated computer models.

    Talk about “No There There”.

    Would more regulation have prevented this house of cards from collapsing? I do not know. I DO know that allowing these Wall Street firms the same advantages of the discount window without stricter reporting guidelines will be utterly abused by the same technologies that brought us here in the first place.

    It seems inherently wrong for Central Banks to be more regulated than investment banks without any real tangible benefit. Which is better  – a more regulated centralied Wall Street or a deregulated decentraliced Main Street. I don’t think I can answer that question as both prospects frighten me equally.

  6. there – I can spell it.  

  7. http://www.rawstory.com/news/m

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