Temporary Bank Nationalization

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I believe it is likely that President Barack Obama and his Treasury Secretary, Tim Geithner, will move to nationalize one or more major banking institutions in the coming weeks. 

This would be a controversial step for the new administration.  And a courageous one. 

The very idea of nationalization is so antithetical to free market economic principles, that this article is bound to illicit alarm and condemnation.  And rightfully so.  Nationalization, especially on this scale, must truly be a last resort.

The two most likely targets are Citibank and Bank of America, with an estimated combined worth of more than $100 billion.  Two banks that are “Too big to fail.”

These banks are also very likely insolvent.  

The Bush administration tried to solve immediate financial problems by investing through the Treasury’s previous $700 billion bailout fund.  Bank of America and Citibank (Citigroup), in addition to receiving their portion of the bailout, also required many additional commitments to insure against losses.  

Lately, the press has focused on scandals over executive pay, lack of accountability for public funds and concern that banks were not doing their part to extend credit. These may be valid, but they obscure the concern that the investment, to date, does not appear to be enough to keep the banks operating.  

So the government has a choice.  

Continue to invest more taxpayer funds, in hopes the tide will soon turn, or face the music and take over the failed entities.  It would be one thing if we were near the end of this recession and the funds were just a bridge to an inevitable recovery, but we’re not. 

Unfortunately, predictions for 2009 are bleak, and as finances go, so does the viability of banks.  A significant rise in unemployment risks another round of foreclosures and a further weakening of bank mortgage portfolios.  

In this light, nationalization is courageous.  With banks insolvent, doing anything else simply puts off the reckoning for a later date.  

Nationalization does not eliminate financial risk, but does give the government the sole right to collect from the sale of bank assets when they are returned to private hands.  

Under this scenario however, current shareholders would most likely see their interests wiped out.

The Obama administration’s plan to support the real estate market is still unknown.  A dramatic act could conceivably stop the mortgage weakness that continues to weigh down the banks, making the path forward more positive. 

However, for the new administration, there is great political risk.  Already facing criticism for preparing to spend nearly a trillion dollars on fiscal stimulus, some of which looks like pork-barrel politics as it goes through Congress, the administration would face a whole new magnitude of concern for its attempt to run the megabanks.
 

There is no doubt that the administration would only be seeking temporary nationalization.  The new team has professed no desire to control or profit from the business of banking, but does have a few good options.  The banks are involved in so many credit, retail and financing operations that a shut down would be disastrous for an innumerable number of its customers still fighting for survival.  

On the other hand, when the bank is returned to private hands, the government, not the current shareholders, would likely recoup much of its investment.

Let’s unlock politics, where do you stand on nationalization of insolvent banks?