If you hid the name of the country and just showed them the numbers, there is no doubt what old International Monetary Fund hands would say when confronted by the current situation of the US: nationalise the banking system. The government has already essentially guaranteed the system’s liabilities , bank assets at market value must be massively lower than liabilities and a severe global recession may yet turn into the Greatest Depression.
Yet no one other than the government is available to recapitalise the banking system. Without sufficient capital, lending cannot be stabilised and any incipient recovery will be strangled at birth.
The total of these figures suggests the government will need to come up with working capital in the region of $3,000bn-$4,000bn. If things go well, the losses to the taxpayer should be quite limited, with the final cost closer to $1,000bn (€766bn, £723bn). But this requires that the taxpayer gets enough upside participation. How is this possible without receiving common equity which, at today’s prices, would imply controlling stakes in the banks – that is, nationalisation? We could receive a large amount of non-voting stock, but a silent majority shareholder is an oxymoron who distorts the incentives of managers towards further bad behaviour (emph mine).
The most politically robust solution is for the government to acquire not voting stock but warrants – the option to buy such stock. These warrants would convert to common stock when sold, and a Resolution Trust Corporation-type structure could manage the disposal of these controlling stakes into the hands of private equity investors. New owners would restructure bank operations, fire executives and break up the banks (particularly if some anti-trust provisions were added).
The sticking point will be banks refusing to sell assets at market value. The regulators need to apply without forbearance their existing rules and principles for the marking to market of all illiquid assets.
The law must be used against accountants and bank executives who deviate from the rules on capital requirements. This will concentrate the minds of our financial elite. Either they will raise capital privately or the government will provide, but this time on terms favourable to the taxpayer. The bankers’ lobby, of course, will protest loudly. Good thing we now have a US president who can stand up to it.
Bottom line points:
1/ unless private capital steps up public capital will need to step in. Problem is that private capital doesn't want to step up because public capital may wipe them out. Self fulfilling prophecy. John Hempton over at Bronte capital talks about "due process" here.
2/ We cannot trust politicians and we certainly cannot trust management. This article aims at a equilibrium of fear. Capital is public, allocation private, accountability thorough. However until Thain and Madoff and other white-collar criminals are thrown in red-neck jails being molested by 300 pound gorillas on death-row I will not believe there is white-collar accountability in the US, it has been made a joke. Young man gets thrown in jail for years for selling dope but madoff gets to stay at home?
3/ Why the distrust of govt. Yes, I know in the past they have made a mess of things. But this time around the invisible hand was robbing shareholder to pay management. I believe, like the authors of this article and the TechTicker folks yesterday, that we have a new administration that talks a good talk about transparency and accountability, let's see them implement such lofty principles instead of groping for complex solutions and hiding behind their little fingers.
Obama should man-up and nationalize, clean up good/bad banks style with due process and participation of private capital (encouraged by due process), shoot the pigs in the head or at least re-introduce the fear of god into this degenerate bunch, recapitalize the good banks and force them to lend to viable concerns, not get in the middle in the process, keep lobbyist and themselves at bay and re-privatize at a profit for the tax-payer in 20 years, move on.
Tall order, but I want to believe we have the man and leadership to do it. I am a naive optimist disguised as a cynic.