The Bad Bank Rally [nyt]
By Eric Etheridge
In the last few weeks, the precipitous fall in bank share prices in the United States and the U.K. triggered much discussion in both countries about the idea of nationalizing banks and creating a new “bad bank” to take over their toxic assets. Now bank share prices are recovering, and while the nationalization strategy is fading — the Washington Post reported this morning that both Timothy Geithner and Lawrence Summers think it’s a bad idea — the “bad bank” notion is apparently catching on with the administration, according to a Wall Street Journal report today, which says that’s why U.S. stocks, led by bank shares, are rallying today.
Dean Baker at TPMCafe thinks a bad bank absent nationalization doesn’t make sense:
It will be important to see the details of the bad bank plan, but it is hard not to be suspicious. The most simple and obvious way to deal with bankrupt banks is to do the same thing that we did in the 80s with the S&Ls: take them over, get their books in order, and then resell them to the private sector. If the Obama administration opts for the far more complex bad bank route (without first taking the banks over), then there are grounds to fear that the motive is handing taxpayer dollars to banks, not rescuing the financial system.
Matt Yglesias agrees:
There’s a consensus developing, that I can’t really evaluate, that we can’t have an economic recovery absent a $1 trillion gift to banks that made poor business decisions.
There are two ways we could make that kind of gift. One would be to just give them the gift, but to describe what we’re doing in a misleading way so as to try to minimize public outcry. Talk about the need to “get toxic assets of the balance sheet” will be prominent here. Another would be to seize control of the worthless, insolvent banks and then make the gift to what are now publicly-owned enterprises. Either approach would be costly, would be the kind of thing you’d normally avoid doing, and would run the risk that the government couldn’t adequately supervise the situation. But the former approach would preserve lots of free money for existing bank shareholders and cost the public extra. If Summers & Geithner have some completely different approach that they think will work, I think that would be an excellent idea. But nationalization, while not something I’m thrilled about, would be better than just forking money for no reason.
At the Asia Times, David Goldman, no fan of nationalization, points out another key element in the recovery of the bank stock prices:
Extremely important, also, is the fact that the Obama administration left mortgage “cramdown” (effectively unsecuring previously secured household lending in the event of bankruptcy) out of the stimulus package, to the utter consternation of left-wing “consumer advocates” and populist Congressmen such as DIck Durbin of Illinois. His supporters are howling, not least because President Obama reportedly told the House leadership personally that cramdown had to scram out of the stimulus package. That is an important test of the new administration. Bank analysts (and pretty much everyone who understands the first thing about banking) have echoed my Jan. 13 warning that cramdown could throw a monkey wrench into the banks’ gears.
It wasn’t a minor matter. As I reported in the linked post, the rally in the top of the subprime capital structure collapsed as soon as CItibank unwisely endorsed cramdown, apparently armtwisted by the federal officials. The fall in asset prices contributed to the run on bank equity that ensued during the third week in January. . . .
What convinced the Obama administration not to play Dr. Frankenstein with the banking system? The collapse of the British pound and the soaring cost of insuring against a British default must have gotten someone’s attention. The sharp backup in US Treasury term yields despite an equally sharp fall in US equity market, moreover, must have alerted some in Washington that the credit of the US Treasury was not impregnable. The worst thing about bank nationalization is NOT that the government will do a bad job of banking. Everyone does a bad job at banking. The worst thing is that it places untold trillions of dollars of new liabilities on the shoulders of a federal government that already is borrowing well over $1 trillion a year. |
