On Bank “Nationalization”?

Let’s deal with this directly, since there have been articles on both Bloomberg and The NY Times in the last couple of days, among other places.

First, some definitions.  Some would claim that we have "already" nationalized the banks via the TARP.  I disagree – a capital injection is not "nationalization", although it shares some characteristics with one.

An FDIC takeover is also not "nationalization".  In an FDIC takeover, such as happened with IndyMac Bank, the FDIC (a government agency) strips off the assets and liabilities and then either runs down the portfolios or sells them off.  There is no intention to return the firm to private ownership or continue operating it in its present form – it is dissolved,

"Nationalization" is control of a financial or other institution by government while it continues to operate "transparently" for its customers and creditors.

The NY Times said:

"The aim is to clean up the banks efficiently, rather than allow the problems to become bigger, and then — as soon as possible — to sell the banks back to private investors. They will be smaller institutions. And there will be proper regulations in place to ensure that this catastrophe does not happen again."

Unfortunately Nationalization will do no such thing.  Nor is it similar to other takeovers done thus far, as is also alleged:

"Critics will charge that government bureaucrats do not have the skills to pull this off. But the United States has a successful history of seizing insolvent banks through the Federal Deposit Insurance Corporation. The takeovers contemplated here are larger in scale and would be more complex than those that have generally fallen under the F.D.I.C.’s purview. But the notion that the government totally lacks the know-how to nationalize insolvent banks is not valid."

Of course it is valid.  When the FDIC comes in and takes over an institution it is not to "clean it up"; it is to resolve it – or rather, to dissolve it.  The insolvent institution effectively goes into a vat of acid, with the precious metals and other valuables dropping to the bottom where they are fished out and sold.  The rest of the firm disappears – literally.

Now on to Bloomberg:

Treasury Secretary Timothy Geithner’s refusal to clarify his intentions regarding either bank “is allowing for the absolute decimation of the values of Bank of America and Citigroup on a daily basis,” said William Smith of Smith Asset Management in New York. At the White House today, spokesman Robert Gibbs said the Obama administration “continues to strongly believe a privately held banking system is the correct way to go.”

Now there’s reporting.  Actual reporting.

"Belief" is not a strategy and is not tradeable.

Let’s once again point out what I’ve pointed out dozens of times before, going back to Fannie and Freddie – The Market always calls all bets.

President Obama’s administration appears to be no more intelligent than President Bush’s in this regard, despite having the benefit of watching Paulson and Bernanke get run over multiple times in this precise same way.

The bank CEOs, particularly Bank America’s Ken Lewis, have likely put themselves in personal criminal jeopardy if they’re lying with statements like this:

"Bank of America Chief Executive Officer Kenneth Lewis said in statement that “speculation about nationalization is based on a lack of understanding of our bank’s financial position as well as a lack of appreciation for the adverse ramifications for our customers and economy.”

Bank of America “is profitable with strong levels of capital and liquidity,” Lewis said in the statement, released by a spokesman."

Maybe true, maybe not. 

But the market isn’t that impressed with such protests, because the last two clowns that made such a pronouncement – Bear Stearns’ Schwartz, Cayne and Lehman’s Fuld – were either lying or wrong and within days (Bear) to weeks (Fuld) their firms collapsed and both of these gentlemen remain free rather than being under indictment.

Clarity isn’t helped by statements like this:

Yingling said he met with Geithner recently and the Treasury secretary wouldn’t directly comment on nationalization.

“He’s been clear that he thinks that nationalization is a bad idea,” Yingling told CNBC. “I see no signs that they’re interested in nationalization.”

The administration simply must get out in front of this mess and start speaking with clarity and honesty as to their intentions and expectations. 

This is not now and never has been about belief, it is about facts, and the market will force the destruction of these firms if there is no clarity provided.

Unfortunately we are unable to "nationalize" the banking system on the grand scale that some have put forward.  Doing so risks the destruction of America; there is roughly $1.2 trillion in debt on the balance sheets of Bank America and Citibank alone, ignoring the "off balance sheet" conduits and other "guaranteed" interests.  The total debt thus involved is likely in excess of $3 trillion if we were to do Bank America, Citibank and, for example, Wells Fargo.

The public float of treasury debt is somewhat over $5 trillion dollars.  To take these onto the balance sheet of The United States Treasury would add more than 50% to that float immediately; this might provoke an immediate sovereign debt rating downgrade for The United States and that (or the jitters that could lead to one) would spike borrowing costs for Treasury.  Since we’re running a deficit of nearly $1.6 trillion in the current budget year this would be catastrophic.

This same issue, by the way, is why Fannie and Freddie have not been consolidated onto the Government Balance Sheet (even though the CBO says we should) and why despite the bleating of Asian Nations we have not issued a "full faith and credit" guarantee for their debt.   Bluntly put, we can’t without serious and perhaps catastrophic consequences for a government that simply refuses to live within its means.

This is where people like Roubini get it wrong; Treasury simply cannot afford a bond market dislocation or any significant increase in short-term borrowing costs when it is running deficits of $1.5 trillion annually.  Any consolidation of these bank balance sheets onto the debt of the United States, whether announced or de-facto, is very likely to produce a near-immediate funding cost spike which could start a destructive or even fatal spiral in treasury funding costs, with the potential outcome being a sovereign default by The United States. 

Treasury, over the last few years, has committed the same idiocy that many corporations did in shifting borrowing to the short end of the curve in order to hold down financing expense – at the cost of adding significant rollover risk.  Should that risk become realized the outcome would be catastrophic.  Many corporations got "schooled" when commercial paper seized up and the dangers of their attempt to shift long-term debt to short-term paper became realized instead of theoretical; we cannot afford such an event on a national scale.

There are many banks that could be taken over by the FDIC and flushed; these are mostly regionals, superregionals and local banks that took on too much debt for their equity position, mostly in the commercial real estate arena, and for whom private capital avenues are closed due to their foolish practices.  These banks have also been hammered in the markets and are in serious trouble; many of them will go to zero and disappear.  They should disappear, as there is simply no way to support them en-masse and further, there is no reasonable expectation that the "assets" they hold will ever have sufficient value for them to be made whole.  In particular, commercial real estate is a far more serious issue for these institutions than residential real estate ever will be for anyone, as we simply have far too many stores, malls (both "big box" and strip) and miscellaneous shops, and as I predicted in my 2009 "Look Forward" Ticker some 20% of all retail establishments are almost certain to close as demand contracts.

But that is not "nationalization" – it is dissolution, with the value being chopped up and sold off.

The "monster banks" like BAC and Citi are not on that list – at least not today.

Everyone wants to talk about "banks not lending" but this in fact false; the banks are lending – to sound credits – and in fact bank credit has been expanding.  There aren’t as many of those sound credits out there, but they do exist.

What has disappeared is the securitization market – that is, the essentially-unregulated "shadow-banking" system.  This money has disappeared as a direct consequence of the fraud that permeated the marketing of these instruments – fraud that went from top to bottom, with borrowers overstating income and understating debts, intermediaries shopping ratings until they got what they wanted (irrespective of the underlying underwriting – or lack thereof – involved) and peddlers who were shoving this debt off all over the world and representing it as "safe" because it had a "AAA" rating – which they paid for.

That capital is gone; those institutions and even sovereigns that have been flim-flammed out of trillions of dollars will not be back until the guilty parties are identified and flushed out, with appropriate penalties being levied.  This means prison time and disgorgement; while there is no way to make the buyers of these securities whole, at minimum those who engaged in this fraud need to be impoverished both to make clear that this conduct will not be tolerated and to provide some solace to those who were taken by their false claims.

There is simply no possible way to "restart" securitized debt until this takes place, and so far, the governments of the world have absolutely refused to take this approach, despite the fact that lying about your income on a 1003 (which all mortgage applicants fill out) is a felony, and intentionally concealing or misrepresenting facts about securities you sell constitutes the federal offense of securities fraud.

Disclosure: I bought some BAC common Friday in the depths of hell; my money (a small amount of it anyway) is where my mouth is.  I am treating this purchase as a LEAP option without time decay on their survival; if they make it this trade is likely a 10-bagger (ten times my original capital); if they fail its a zero.

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