Grandstanding and the Case for Nationalization
Bailed out bankers are now whining about political interference in the operation of their businesses. Kevin Drum rightly suggests that this is relevant to the debate over whether or not the government should formally take control over the most-distressed large institutions:
Some things just make sense: if you’re accepting bailout money because your capital has become dangerously low, then it’s hardly unreasonable to demand that you stop depleting capital even more by continuing to pay out full dividends. That’s directly related to the problem at hand and it’s a reasonable regulatory response to a serious problem.
On the other end of the spectrum, though, you get populist grandstanding like the recent fuss over Northern Trust hosting a bunch of client parties at a golf tournament they were sponsoring in Los Angeles. Aside from the fact that money for the events all came out of the bank’s marketing budget — which no one in their right mind thinks should be shut down during a recession — they almost certainly would have wasted more money by calling off their parties than by holding them. Those kinds of things are scheduled far in advance, and the contracts they signed probably didn’t allow them to recover more than a pittance if they cancelled at the last minute. So if they had cancelled, they would have ended up paying out 90% of their budget and getting nothing for it, instead of paying out 100% and getting something in return.
Now, you can argue that they should have cancelled anyway purely for the PR value. And maybe so. And it’s obviously a judgment call about what kinds of rules should apply to bailed out banks that ought to be conserving cash. Still, those of us who tentatively favor nationalization should also favor a process that keeps Congress at arm’s length. The whole point of nationalization is to restore both solvency and confidence, and let’s face it: sober management isn’t really Congress’s stock in trade. I’m not quite sure where the balance lies, but it’s worth an open discussion.
I think that’s precisely right. But I also think it’s part of the case for nationalization. You guarantee the debts of the above-water banks (which should work out okay since the banks are above-water) and assume responsibility for the debts of the under-water institutions. But in exchange for doing this—which will cost a ton of money—the government assumes ownership and control over the under-water institutions. It then appoints a new board (which appoints a new CEO and some other executives) and directs them to sell off its assets and properties over time all the while making management decisions driven by a desire to maximize profits. The point here is that since the public owns the bank, the profits belong to the public. So the publicly-owned bank has a mandate to serve the public interest—by maximizing profits. And this then becomes not only a relationship that’s formally at arms-length from congress but an actual reason for congress to avoid screwing around with the bank. The bank is being managed to make money—for you! To recoup the losses you incurred when the bad debts were paid off.
The current situation, while minimizing formal public control, actually maximizes the level of BS grandstanding. You have you public funds flowing to private institutions. We’re told that this is necessary to serve the public interest. But that means that each and every decision taken becomes open to scrutiny from a public interest point of view. Does the golf tournament really serve the purpose of getting credit to flow? How come you took a taxi to the airport instead of a bus? It never ends. If the publicly supported institutions are also publicly owned, then you have a rationale for minimizing this kind of nickle-and-dime political posturing.
29 Responses to “Grandstanding and the Case for Nationalization”
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March 11th, 2009 at 3:25 pm
I was talking last night with a friend who is an exec at a major US bank. They are working to pay back the TARP money as fast as possible. This was a bank that was profitable last year, did not request TARP funds, and was minimally involved in sub-prime lending. This bank is still originating billions in new mortgage loans.
But they’ve been dragged through the mud by lazy news reporters who whipped up a travel ’scandal’ because the firm was rewarding their successful loan originators. Had this bank not been forced to accept TARP funds (the gov’t decreed that everyone had to take funds or else we’d all know who the REALLY troubled banks were), then there would not have been the perception, however bogus, that the firm was spending “our” money on a Vegas jaunt.
Well, said jaunt was canceled, to the notable disappointment of lots of workers in Vegas (as well as the successful loan originators). The kicker is that the firm lost millions in deposits in Vegas anyway, so the only thing saved was some lazy journalists’ butts.
Now, that said, the banks that are actually under water should probably be nationalized and have their boards and C-suites cleaned out as well as their balance sheets. Just let’s distinguish the bad from the well run banks, please.
March 11th, 2009 at 3:25 pm
Also one must take into account that the treasury wanted strong banks to take “bail out” money so that weak banks would not be pin pointed.
March 11th, 2009 at 3:27 pm
Matt writes:
“The point here is that since the public owns the bank, the profits belong to the public. So the publicly-owned bank has a mandate to serve the public interest—by maximizing profits. And this then becomes not only a relationship that’s formally at arms-length from congress but an actual reason for congress to avoid screwing around with the bank. The bank is being managed to make money—for you! To recoup the losses you incurred when the bad debts were paid off.”
If that’s what the government is calling “nationalization”, count me out. Under this scenario, taxpayers end up footing the bill for the enormous losses the zombie banks will likely incur. Banks run by congressional committee are unlikely to perform well, thus adding to the taxpayers already considerable pain. What’s wrong with putting the banks in receivership, wiping out the equity holders, selling off their assets to the private sector and giving the proceeds to the bond holders and counter parties? Why must we “assume responsibility for the debts of the under-water institutions”? These bond holders and counterparties are hedge funds, other broker/dealers, pension funds, insurance companies and other very sophisticated investors. They screwed up too. Why should the US taxpayer be left holding the bag for the poor financial decisions made by some of the worlds most savy investors? What lessons would the masters of the universe take away from this event?
March 11th, 2009 at 3:43 pm
Unless the government wipes out the existing shareholders the board of directors will continue to work exclusively at maximizing shareholder value.
If a majority shareholder (i.e. the government) tries to use its power to do anything else, the minority shareholders have the right to sue on behalf of the company. So, not only would the government not want the company to do anything other than maximize shareholder value but it doesn’t really have a choice. Of course if nationalization becomes de facto expropriation this won’t really matter and the government can do whatever it wants.
March 11th, 2009 at 3:49 pm
Unless the government wipes out the existing shareholders
I think the assumption is that the existing shareholders would be wiped out. By defnition, the “under-water” banks have negative value, so the shareholders should be wiped out.
March 11th, 2009 at 3:51 pm
Oh, sorry, I forgot what a slimeball liar Gordon Gekko is and made the mistake of treating his post seriously. My bad.
March 11th, 2009 at 3:53 pm
I don’t really understand this whole maximize the taxpayers profit thing. The government is not a private equity firm. The way you maximize the benefit for the taxpayers is by getting the banking system running again and getting all the money returned to the treasury plus interest. That would be a fucking home run for the taxpayer. This idea of trying to increase the return by x number of basis points is asinine.
Anyway, the stress tests will show that there are one or two problem banks out there and the rest are pretty much fine as long as they can maintain their funding and get the government to give them some time. They will earn their way out of this and sell off a few assets along the way to the stronger banks.
March 11th, 2009 at 4:07 pm
DTM,
I’d also note that when talking about failed banks, you always have to account for the insured depositors, which in fact is one of the reasons why it may not be smart for the taxpayers to insist on a liquidation–even if that totally screws the other creditors in a very emotionally satisfying way, it may actually screw the taxpayers as well if they end up out a lot of cash to the depositors.”
The FDIC covers depositors. There is another Federal program that covers at least some of the potential losses for brokerage accounts but let’s not confuse depositors with counterparties. If you have money in a checking or savings account at Citi and they fail, you’re protected. The FDIC doesn’t rely on asset sales to pay off depositors.
The whole point of a liquidation is not punishment for the banks alone but punishment for the counterparties as well. It’s the most efficient way to clear the rot clogging up the credit markets. All the interested parties know there are losses coming but they’d much prefer those losses fall on someone besides themselves. The target of choice is the US taxpayer. I submit the losses rightfully belong to the people who entered into these contracts. Their is a bigger issue here. What some call the “moral hazard”. If big, sophisticated institutions and the people who run them get to take huge risks, reap huge rewards when the bets pay off, and pass off the carnage for failed bets to the taxpayers, we’re likely to find ourselves in a similar situation very soon.
March 11th, 2009 at 4:10 pm
DTM,
So, if nationalization occurs shareholders get nothing because the equity isn’t worth anything. If this is true then why are these companies’ equity still valued at billions of dollars.
Either they expect to receive something from nationalization or the equity is worth something.
March 11th, 2009 at 4:14 pm
DTM,
Just saw your comment which largely answers my problem.
But if they do keep private equity holders doesn’t this limit their control over these banks?
For instance say they as majority shareholders want to increase lending but it is not in the company’s interests. Now the private shareholders (under normal circumstances) would have the right to sue.
March 11th, 2009 at 4:20 pm
DTM,
There’s a bloomberg story today about the increased spreads on bank debt. It makes the case that the bond market is anticipating a haircut for bond holders.
http://www.bloomberg.com/apps/news?pid=20601087&sid=auYhD0QCKYjg&refer=home
March 11th, 2009 at 4:26 pm
DTM,
Yes, the FDIC tries to find a buyer so they don’t have to pay off depositors. In the event they can’t find one, they cover the depositors out of their insurance fund. If that fund runs out of money, they borrow from the fed. They enjoy the full faith and credit of the US government. You implied that depositors would have to stand in line like other creditors which is incorrect. The FDIC covers them up to the insured amount which was recently raised to $250,000. Secured creditors like bond holders and counterparties enjoy no such guarantee.
March 11th, 2009 at 4:37 pm
Ralf: Your friend works for Wells Fargo! No point cloaking it in “major US bank” when you give that many details about their situation.
March 11th, 2009 at 5:02 pm
DTM,
Completely agree on the first part. But I am still not sure about how the government as an equity holder can legally exercise control.
What you are saying is that because congress controls interstate commerce it can control what banks do. Agreed, but this doesn’t mean congress can tell Citigroup not to throw a party the way shareholders could. It can say a certain class of bank cannot hold parties but not just one company. And even if it does try to interfere congress is slow, much slower than, say, shareholders holding a vote.
Also, if what your saying were true there wouldn’t be any value in the government actually owning common shares. They would be happy with the preferred shares they’ve already got. Any control they want over the banks could just be imposed by fiat.
What I want to know is if the government becomes a shareholder does this change the rules governing a corporation. As shareholders they can control the bank to some extent but it opens up a whole host of questions relating to corporate law.
March 11th, 2009 at 5:58 pm
I’m just going to keep saying this: DON’T GUARANTEE DEBTS OF INSOLVENT BANKS. If you just let the bondholders eat their fair share of the loss, according to the law, the cost to taxpayers gets much less and moral hazard is minimized. If some of those bondholders turn out to be little old ladies and orphans you can bail them out selectively. Everyone else was a consenting adult in this mess and deserves to pay their fair share.
March 11th, 2009 at 6:22 pm
DTM,
I agree. The taxpayers will eventually take a hit because the size of citi would overwhelm their bailout funds. My point was the depositors funds are guaranteed by the full faith and credit clause. Taxpayers have no choice about bailing them out. For me, it comes down to this. I’d rather my tax dollars go to depositors who aren’t responsible for wrecking the bank rather than to bond holders and counter parties who were all part of a system that was. Bailing out depositors might be expensive but not nearly as expensive as making the counterparties and bond holders whole. Besides, if the federal government just waves it’s magic wand and moves all those liabilities to the treasury balance sheet, did we solve the problem or create a bigger one?
March 11th, 2009 at 6:32 pm
From tomorrows testimoney on mark-to-market accounting. A great example of why the current crisis has been overstated by accounting standards.
http://www.house.gov/apps/list/hearing/financialsvcs_dem/bailey031209.pdf
March 11th, 2009 at 6:44 pm
Here’s an even better example….
http://www.house.gov/apps/list/hearing/financialsvcs_dem/isaac031209.pdf
March 12th, 2009 at 8:11 am
Enough. I’m no Scalia, but stop abusing the language. “whether or not” means “regardless of whether.” This is not that difficult to get.