Nationalization Isn’t a Dirty Word

The time has come to acknowledge the depths of our problems. It has already been demonstrated that propping up failing institutions does nothing but delay the inevitable. It consumes staggering sums, it wastes time, and it prolongs what will invariably prove to be one of the sharpest economic downturns in generations. A downturn that originated not in the real economy, but in the financial economy. The credit bubble fueled the housing bubble, shortly after the stock market bubble had been pricked. Easy money plus poor regulatory constructs with a touch of fraud was just what was needed to bring down the system. Sadly, many companies and industries have been effected that had nothing to do with and extracted little benefit from the financial bubble. So while our financial institutions are getting their comeuppance, the rest of the economy is being dragged down with them. It is just wrong, simply not fair, but it highlights the importance and interconnectedness of our financial institutions with the other engines of our economy. Without a healthy financial sector, the real economy simply cannot flourish.

Today we are lost. Our leaders are wandering around, trying to address the problems in a patchwork manner. Pork abounds. None other than Barney Frank, head of the House Financial Services Committee, used his position to extract funds for a small institution in his home state. As long as the rescue plan is administered in this manner more money will be wasted, confidence will be destroyed and little progress will be made in helping get our financial sector – and, therefore, the rest of our economy – back on its feet. The time has come for a change.

The answer lies in the complete takeover of sick institutions. Call it nationalization, call it what you will, but it is the most expedient, most cost efficient and ultimately least disruptive way to accomplish what needs to be done. The goal is not to have huge swaths of the US financial sector owned and controlled by the Government. They are particularly bad operators and skew market forces, and should be viewed as a catalyst, as a stop-gap to address the current crisis. Fact is, they are the only institution with a large enough balance sheet and the power to jump-start the healing process, which means segregating illiquid assets (Bad Bank) from performing, liquid assets (Good Bank), warehousing and working out the Bad while selling off or spinning out the Good. While this would wipe out the common equity and much of the debt of sick institutions, it would end the charade that there is any real equity and debt value left in many of them, save for the largesse bestowed upon them by Treasury via TARP. Time to end the largesse and the pork and to get on with the hard work of really solving the financial sector’s problems.

The newly-created Good banks will have clean balance sheets, rational capital structures and be open for business. They will be able to lend money without fear that they’d be better off saving it, and will make rational lending decisions without Government intervention. A group of healthy banks in a sick economy does not mean that lending will all of a sudden take off. The prudent banker will only invest when risk-adjusted returns are sufficiently attractive. But those healthy companies that have been squeezed by the credit crisis will now have access to better-priced capital, and will have a range of institutions offering competitive rates from which to choose. This condition does not exist today because of the fear across the banking sector. Unfortunately, only the Government can take away this fear by using its balance sheet as a bridge to clean things up. But rather than squandering taxpayer dollars by “insuring” the walking-dead banks of today against portfolio losses, the money would be better spent marking bad assets down, letting the US taxpayer pay a depressed price, creating optionality by warehousing them on the Fed’s balance sheet and selling them after the credit market dislocation has abated.

What this really amounts to is a virtual restart of the US banking sector. Mistakes have been made on a scale too massive to imagine, and it is up to us to deal with these mistakes thorugh a combination of decisive action and sensible regulatory changes. But let’s not get too hung up on terminology; there is work to be done.

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