Nationalization, Like it or Not?

On the debate of what will happen with the economy and the banking industry, I am trying to have this conversation with as many people as possible because I don’t think anyone has a clear idea of what is going to happen so it helps me to engage as many people as possible and create discussion. I find it interesting to trade ideas, find out where I am wrong, right, or close.

There is a bigger debate regarding the fact that world operates on a dollar standard and the US is the world’s largest debtor, foreigners buy US debt largely out of the confidence that we will always have the means to pay it back. There are some “darker” scenarios I have heard discussed about the US experiencing hyper inflation, current holders of US debt flooding the market with our own notes, the dollar falling drastically in value, and gold running to $7,000 an ounce. Under the presumption that this does not come to fruition, lets just discuss the banks.

In a conversation with two friends, they both mentioned that the RTC of 87' was for all intensive purposes a bad bank and dispensed of the assets back into the private sector. That is not correct in my understanding. The RTC would look at a bank, decide it was insolvent, close the bank, and then sell it’s assets. They closed over 1100 Savings & Loans in all. They did not take bad assets or non performing assets off the balance sheets of S & L's banks and sell them. Two key points exist to establish that it is not possible to address this current problem with an RTC type solution. The first, the damage and insolvency we are dealing with now goes far beyond Real Estate and Junk Bonds, the issue rests with trying to stave off a systemic failure of the consumer banking system, can you imagine the RTC approach, our government comes in and closes B of A or Citibank? It is not going to happen. This means the fundemental RTC legislation and how the 87' RTC operated does not apply here. This leads me to the second point, You mentioned a scenario, "What if we just take all of the bad assets off the balance sheets of the banks, and essentially cleanse them from the system?" If our government was to do that, the banks would be forced to immediately recognize the full value of the loss on its balance sheet. Because most of our major banks are publicly traded and the value of the loses would be so overwhelming, the net result would be a complete and total wipe out of shareholders equity. Banks rely on this equity to borrow and operate, without it their stock price goes to $0 and they fail. This is one of the main reasons the Treasury changed directions and got away from doing this with the TARP funds. Once they got an idea of the scale of the problem, that it was in the trillions, not billions, this option became more like a drop in the bucket. The idea behind the current TARP deployment was that the money would be used by the banks to bolster their balance sheets, complete mergers, and stabilize their finances. This theoretically should have worked if the banks started lending to each other and credit markets were not frozen, the 10, 20, or 45 billion in TARP funds would actually be able to buy that bank substantially more financial strength through the traditional use of assets for leverage, thus restarting the credit markets. It also allowed the Fed to believe that the money appropriated from congress could be spread far enough to actually do some good towards fixing the problem. The Fed was ultimately wrong about believing that banks would meet them more than half way and start trusting one another enough to unfreeze credit markets. It is the same unbridled free-market theory that Greenspan hedged his bets on. Where he guessed wrong and has now admitted, was that an institution would not create a system or market transaction based solely on greed even if it meant a high risk of their collapse in the future. Ultimately the institutions survival would be more important than short term greed. Beautiful and idealistic but not true.



Below are some graphs I scanned from Time Magazine, they show the erosion of value in the banks and how the TARP money has essentially been a non-factor in stabilizing the industry.








The reality is that credit markets, lending, and liquidity continue to degrade because the leverage ratio for banks globally is so far beyond a level or threshold that would allow institutions to start lending to one another again.



Here is another chart from the Time Magazine article that I found interesting dealing with Assets versus tangible equity.








How we claw back such huge ratios into a system that is going to function again solely on the private side is something that Banks are not able to do. It goes against the way they are wired as institutions, they will not look to help each other even if it means they will ultimately be harmed themselves. The Lehman failure is a perfect example; we now see the ripple effect that the failure of Lehman had on the world financial markets but at the time the only thing that Lehman’s fellow bankers, who are now felling the effects of that failure, saw was a carcass that they could pick clean for cents on the dollar.

I am not for nationalization…I believe in the free market economy, a free market economy that avoids moral hazards and fatalistic greed. I believe the ultimate “right direction” is full private enterprise with sensible regulations and oversight. I am not naive or idealistic to believe that greed is a condition we humans can self regulate. That said, and with the acknowledgement that we have already seen “nationalization” on an unprecedented scale for this country I have more faith in our democracy to push the banks in the right direction with OUR money than I do in writing any more blank checks to a dysfunctional and broken industry.




Read the article from Time Magazine below, it is where the charts above were taken from and I felt it was interesting.



http://www.time.com/time/business/article/0,8599,1874702,00.html


Look forward to your thoughts and insight.