Expropriate the banks!

Sorry, I couldn't resist the headline idea. After all, it's not every day we're on the verge of a new Great Depression.

But that is what happens when a bank becomes insolvent. The federal regulators take it over. Then they dispose of the loans and others assets, either by selling them off or by managing the institution until it can be reprivatized as a solvent concern. In normal times it's not called "nationalization" or "expropriation".

But it's important to distinguish that procedure from what the Bush administration did to inject capital into large banks. They bought preferred stocks in the company. That is actually partial nationalization, since the government acquires an ownership interest in the company. But they didn't take over management of those banks. And that meant that the existing management could stay in place and that stockholders did not have to take losses of 100% of the value of their stocks in those companies.

In cases like IndyMac or Merrill Lynch or others where the company was going under, they either took over the institution or arranged for it to be acquired by another one.

If banks like Citigroup and Bank of America are actually insolvent, what needs to happen is for the federal government to take control of them, replace the failed management, leave the stockholders with their losses and put them back into a condition where they can operate as a going concern. Jamie Galbraith explains what should not happen, but might (Due Diligence, Damn It! Oxdown Gazette 02/13/09):

What Secretary Geithner needs to do is, is assign teams to examine the banks. He must do this, before taking the fatal step of guaranteeing their assets. Examination, as in, look at the loan tapes underlying the mortgage-backed securities. Look at them. This is called "due diligence." Or, not buying a pig in a poke.

It will become clear that the banks either (a) do not have the loan tapes, and hence can say nothing about the quality of the underlying mortgages, or (b) where they do have the loan tapes, that sub-prime securities are deeply infected by fraud and misrepresentation.

We know this, because of the losses already incurred, and some evidence from inspections that have actually occurred.

When this becomes plain, it will be clear that there is no upside to these assets. They cannot recover. They are, essentially and for the most part, doomed to default. Therefore it is wrong to speak of the taxpayer "assuming the risk." The Treasury is proposing to take on a sure loss, thus to make a massive transfer to bank stockholders and incumbent management. With no effect on the balance sheets of the American public - and therefore no chance that credit and credit-fueled economic activity will revive.

That, so far as I understand it, is the economics of the Geithner plan.

This appears to be his first blog post at Oxdown Gazette, part of the growing FireDogLake blog empire. I hope we'll be seeing a lot more of them.

Also on the topic of nationalization, Banks of America - Experts: Nationalization Is Only Way Out by Michael Gray New York Post 02/15/09

Tags: james galbraith, us+economy