Damn commies!

It may be one of the signs of the apocalypse when influential Republican senators start recommending nationalization of businesses, in this case banks. It’s like a Democrat going off on an anti-abortion tirade: it’s just not supposed to happen. So when it does, the press takes notice.  

And the financial press jumped right into this fracas, in many cases encouraging it. In arguing for nationalization, the press focused on two historical precedents from the late 1990s. The first was that Sweden did it effectively; the second was that Japan chose not to do it, and endured a “lost decade” of “zombie” banks and no GDP growth.

However, there was a surprising number of misrepresentations running through that editorial firestorm, the most egregious of which was the use of the term “nationalization” in the first place. First off, we do not nationalize banks—or any other business for that matter—in this country. Ever. What we do is take over banks with a regulatory process using the FDIC as part of a government guarantee of bank deposits. The government doesn’t own these banks for an extended period of time, and in most cases they already have another bank ready to take ownership in return for making good on the seized bank’s deposits before they even step in.

In fact, the last time I checked there were about 170 banks on the FDIC’s watch list, out of almost 10,000 in this country. When most of those go bad you won’t hear much about them except a quiet Associated Press article on an inside page of your local daily on Saturday (they’re always taken over after the market close on a Friday afternoon).

If we’re already doing it, and it’s no big deal, then what exactly were those Republican senators driving at?  

Well, it appears the government doesn’t want any large banks to fail because it believes we cannot afford another Lehman Bros.-like bankruptcy. That one clobbered the interbank market for months and almost collapsed the entire financial system (one can bet ex-Treasury Secretary Henry Paulson wishes he had that decision back—but that’s another story).  However, most of the large banks don’t appear to be in trouble, except two. Oh, and those two aren’t just large, they’re huge: Citibank and Bank of America.

Problem is the Treasury has already agreed to guarantee those banks against bad mortgage loans. Thus, if the banks can’t be insolvent because of those guarantees, a regulatory takeover (which is triggered almost mathematically by a lack of sufficient reserves) is out of the question, and nationalization must be used instead. This would be a historic event, and the term nationalization might actually apply.

But let’s step back in history a few short months and see if this makes sense. While Paulson was in charge, he applied a larger version of the FDIC method (selling off bad banks to other stronger institutions) to save a number of huge financial failures. The Federal Reserve Bank got AIG, the Treasury got Fannie & Freddie and then he looked to other companies to take the rest. JP Morgan got Washington Mutual, Wells Fargo jumped on Wachovia and Bank of America took Merrill Lynch after taking responsibility for another large pool of toxic assets when it bought out Countrywide Mortgage on its own. The Treasury then guaranteed a large pool of Citibank mortgages to prop up that player, primarily since no one else could digest it and bankruptcy was out of the question after the Lehman debacle.

Finally, to make sure no otherwise solid banks came close to the FDIC’s reserve limits during this crisis, the government made preferred stock capital infusions into these and many others with the first half of the $700 billion bailout package last fall.  

Not a bad piece of work actually (although it would have been nice to get compensation and bonus restrictions for that preferred stock, but in the rush it was overlooked).  

However, before closing its deal, Bank of America started making noise it wanted out of the Merrill Lynch acquisition, having decided it couldn’t digest those losses after all. So the Treasury offered Citibank-like loan guarantees on Merrill Lynch’s questionable assets just to get BofA to complete the acquisition.  

While the devil is deep in the legal details, it’s hard to see how the government could nationalize Bank of America now after encouraging it to take Merrill Lynch against its wishes. That smacks of a $100 billion shareholder lawsuit.

Citibank, on the other hand? Maybe. Yet while Sweden ultimately nationalized only its one largest bank (which fits Citibank, actually) and has since returned it to the private sector, it’s clear the Japan scenario isn’t going to happen here after Paulson’s efforts with the huge institutions and what the FDIC is quietly doing with all the others.

That this is even being considered isn’t good news. But one great thing did come out of this: now we all have another way to tease our Republican friends. We can start calling them damn commies. MTW

Doug Levin is a Maui-based CPA.