Or, In The Alternative ....

by von

Matthew Yglesias:

I agree with Chris Dodd on the merits about this but I’m not sure it’s wise for someone in his position to be thinking aloud like this:

Senate Banking Committee Chairman Christopher Dodd said it may be necessary to nationalize some banks for a short time, as Citigroup Inc. and Bank of America Corp. tumbled today on concern the U.S. may take over both banks.

....

... I don’t think we need policymakers musing about this and potentially creating problems for non-insolvent banks. What’s needed is action, not talk. Actually, what’s needed is silence, then action, then talk.

Ahhh.  The "let's surprise the markets" strategy of delivering bad news.  Because, of course, markets always react well to shocks, twists, and surprise nationalizations of gigantic US financial institutions.

I'd like to see Sen. Dodd shut up about a whole boatload of things.  And it's certainly true that the uncertainty lingering over CitiGroup and BOA is damaging their share prices.  But is that a bad thing?  I'd say no:  That's the point.  Nationalization is going to wipe out the equity value of these institutions.  Investors are going to get creamed.  Talking about nationalizing CitiGroup and BOA before the government may (or may not) do it allows the market to fairly price these companies.  Investors get to decide if they want to stay with CitiGroup and BOA and risk taking the hit, or get what they can now and leave. 

Folks who don't like the risk and sell now at a loss, of course, lose out if there isn't a nationalization and these banks recover. And Dodd's comments probably make it marginally more likely that a nationalization will occur based purely on their effect on Citi's and BOA's prices.  But this isn't a perfect world, and there aren't perfect solutions.  By conveying critical information to investors, Dodd gives investors the opportunity to make a choice based on their tolerance for risk.  On the other hand, if Sen. Dodd and a ninja task force from Treasury nationalize CitiGroup and BOA in the middle of the night, surprise!, everyone gets nothing.

Indeed, you want to see real panic in the financial markets?  Implement plan "silence, then action."  Investors can't possibly price other toubled banks if there's always a possibility that Uncle Sam, unbeknownest to all, is going to sweep in and render their investments valueless.

Markets need information, the more the better, to do their job.  Give investors -- give us, give your mom, give your 401(k) fund manager -- the information they need to protect themselves.

Comments

[Fraud Guy]

I generally agree, though I do hold out hope for one alternative.

That the idea is not to surprise the markets, but those responsible for the excess; the bank and finance executives, etc. I prefer that they are notified Blago style; i.e., where they are woken with a call that the FBI is waiting outside, and you please let us in without raising a fuss so we can arraign you and start securing the documentation.

[Wagster]

You're missing a key element... the stress test.

If you do the stress test, nationalize the banks that can't make it, and give a clean bill of health to the ones that can, you're not creating a panic. You're clarifying things for the market. Letting them know the bad apples are out of the batch.

Yglesias is right. Dodd messed up. It's okay for Graham to muse about this stuff, but Dodd actually has power. By talking about this he is bringing into jeopardy companies that might be on the bubble or just outside of it.

[von]

That the idea is not to surprise the markets, but those responsible for the excess; the bank and finance executives, etc.

I can understand that feeling, but there's no satisfying way of punishing folks without shooting ourselves in the foot. And you don't want to create a system where the incentives lean too far in the opposite direction, or else you'll end up with a whole different set of problems.

[Ugh]

On the other hand, if Sen. Dodd and a ninja task force from Treasury nationalize CitiGroup and BOA in the middle of the night, surprise!, everyone gets nothing.
Indeed, you want to see real panic in the financial markets? Implement plan "silence, then action."

Isn't this exactly what the FDIC does all the time (and especially nowadays)? That is, secretly swoop in on a bank after closing on a Friday afternoon and nationalize it without advance warning?

[now_what]

Was WaMu nationalized? I thought it went into receivership. Are the terms being used interchangeably now?

[J. Michael Neal]

Von, you misrepresent Matt's point quite egregiously. He doesn't say that the reason to be quiet is to prop up the price of the banks that need to be nationalized. It's to prevent a run on the banks that don't need to be nationalized. He explains this in several other posts. You chose to ignore his explanations, and present his idea as based upon something other than it is. The point he actually makes is very good.

[von]

You're missing a key element... the stress test.

The stress test is irrelevant to this point. The question is whether it's a good or bad thing for Dodd to be speculating about the alternatives if these banks fail the stress test.

Isn't this exactly what the FDIC does all the time (and especially nowadays)?

Yes, although most banks should issue going concern warnings prior to an FDIC receivorship.

The difference here is that the government has already inserted itself into the mix by proposing alternatives short of, and different from, nationalization. Thus, it's highly problematic if the government only talks about the alternatives to nationalization -- and then suddenly nationalizes.

[Fraud Guy]

von,

I said I generally agree, and feel it should actually happen as Ugh describes.

Would it not be a salutory experience for the insolvent banks to be cleaned of the executives, boards, and shareholders who drove it into the ground, so that the markets know that the one that are left are good, and the assets can be picked up by them as they are able?

From what I have seen on several of the financial boards, the lack of certainty has been the biggest drag on the financial markets.

And would it not reduce the moral hazard of deciding to run your bank into the ground to maximize your profits if we clawed back the bonuses of the last few years, and the parachutes of folks such as Mozillo?

[von]

Von, you misrepresent Matt's point quite egregiously. He doesn't say that the reason to be quiet is to prop up the price of the banks that need to be nationalized. It's to prevent a run on the banks that don't need to be nationalized. He explains this in several other posts. You chose to ignore his explanations, and present his idea as based upon something other than it is. The point he actually makes is very good.

Respectfully, J. Michael, you misrepresent my point quite egregiously. I don't mention (or care) that Matt Yglesias thinks his proposal will "prevent a run on the banks that don't need to be nationalized." It will not have that effect; it will instead have the opposite effect, for the reasons I note.

You can be sincere in your advocacy of a bad idea, and I'm sure that Yglesias is sincere here. That does not keep his idea from being bad, however.

[ThatLeftTurnInABQ]

Yglesias is right. Dodd messed up. It's okay for Graham to muse about this stuff, but Dodd actually has power. By talking about this he is bringing into jeopardy companies that might be on the bubble or just outside of it.

I agree with von here. Dodd does have more power over the fate of the banks than an average Senator, but he can't act alone. If this were a more normal climate, then Dodd would be irresponsible speaking in a casual fashion like this about a possible failure, but today he is not exactly at the head of the parade.

[Almost the entire econ-blogosphere]: The banks have failed! Nationalize them!

[Many prominent mainstream economists]:The banks have failed! Nationalize them!

[CNBC, on an hourly basis]:the banks are failing! ZOMG the end of the world as we know it!!!

[The guy who runs the hot dog stand at the beach]:the banks have failed! Nationalize them!

[Chris Dodd]: Gee, maybe the banks are failing. I wonder if we might need to consider nationalizing them?

[Thud. Banks drop dead]

[Audience]: Chris Dodd did it! He killed the banks!

..ummm, no. Doesn't pass the sniff test.

[Ugh]

Respectfully, J. Michael, you misrepresent my point quite egregiously. I don't mention (or care) that Matt Yglesias thinks his proposal will "prevent a run on the banks that don't need to be nationalized." It will not have that effect; it will instead have the opposite effect, for the reasons I note.

Aren't you talking about investors, which generally have nothing to do what is generally thought of as a "run" on a bank which involves its depositors? Which is what the FDIC is attempting to prevent with its Friday after close takeovers?

[Nell]

I'd like to see Sen. Dodd shut up about a whole boatload of things.

Any point to this nasty little drive-by? What has Sen. Dodd been talking about that annoys you so?

[Fraud Guy]

Would it not be a salutory experience for the insolvent banks to be cleaned of the executives, boards, and shareholders who drove it into the ground, so that the markets know that the one that are left are good, and the assets can be picked up by them as they are able?

I hope that wasn't precognitive Freudian slip on my part.

[Neil the Ethical Werewolf]

von, if you don't care that Yglesias thinks his proposal will prevent a run on those banks, you shouldn't have bothered to cite him. That's the whole point of his argument, and you should at least address it if you're going to criticize his conclusion.

And he's right, anyway. If you surprise the markets with the announcement "We've examined the assets of 20 banks. We're nationalizing banks 1-6. Banks 7-20 have a clean bill of health" you prevent a run on 7-20. Meanwhile, if you start making noises about nationalization and nobody knows what's going to happen to whom, 7-20 can face a run.

In short, you neglect that this would involve good news for some banks even as it involved bad news for others.

[J. Michael Neal]

Respectfully, J. Michael, you misrepresent my point quite egregiously. I don't mention (or care) that Matt Yglesias thinks his proposal will "prevent a run on the banks that don't need to be nationalized." It will not have that effect; it will instead have the opposite effect, for the reasons I note.

No, Von, you don't. You quote Yglesias, and then you talk about the share prices of the banks that are insolvent. You never mention the banks that won't. That thought is completely missing from your post. You can claim that was your point all you want. Maybe that was even what was in your head. What you said, though, is about the banks that will be nationalized. You say, "On the other hand, if Sen. Dodd and a ninja task force from Treasury nationalize CitiGroup and BOA in the middle of the night, surprise!, everyone gets nothing." Your talking about the nationalized banks, not the non-troubled ones.

Further, you may not care what Yglesias' point is, but you do describe it. Falsely. He called for Dodd to shut up, and you claim that it is about the banks being nationalized. There is no way to read that and not think that that's the point you're arguing against. It's a complete strawman.

You may disagree with what Yglesias is saying, but you should at least manage to argue with his actual position, and not your imagination.

[Ugh]

The difference here is that the government has already inserted itself into the mix by proposing alternatives short of, and different from, nationalization. Thus, it's highly problematic if the government only talks about the alternatives to nationalization -- and then suddenly nationalizes.

But they are nationalizaing banks now, despite what they might be saying. In fact its been going on for months, why so different now?

[cleek]

On the other hand, if Sen. Dodd and a ninja task force from Treasury nationalize CitiGroup and BOA in the middle of the night, surprise!, everyone gets nothing.

aren't we talking about this because those banks are worth essentially nothing (or less than that) ?

who should get anything ?

[hilzoy]

One of the reasons I favor nationalizing insolvent banks and sacking their management -- while making it as clear as we can that others are solvent -- is precisely to get incentives right.

If we just let things take their normal course -- insolvent banks are placed in receivership, etc. -- Citi would already be there. By propping it (and others) up, we have already screwed incentives up, and created a gigantic moral hazard problem. Making it clear that if you run a bank and it goes insolvent, you personally will lose your job would go some way towards correcting that problem.

[ThatLeftTurnInABQ]

JMN,

Leaving aside for the moment the von - yglesias cage match, can you answer me something regarding the substance of what MY said?

I'm imagining that there are some people who had no idea at all that the banks are in trouble until Dodd spoke up, and are now thinking "hmmm, maybe I better go get my money out and stuff it in my mattress", because they don't understand the relationship between the FDIC and depository accounts, or don't believe in it. I'm fairly certain such people exist, because I know a few of them personally.

I also imagine that there are some people who are well informed enough to know who Dodd is, what role he plays in the Senate and why his words might carry more weight than some random talking head on the TV, or even somebody like Roubini or Krugman. Again, I know some of them.

What I'm having a hard time imagining is that the intersection of these two sets of folks is a non-trivial population.

How do Dodd's comments trigger a run on deposits, if this is the case?

It seems to me that courtesy of the comingling of commercial and investment banking we have a real problem in terms of how to manage discussion of what to do with the big banks. Somehow we have to talk openly and frankly about issues like nationalization, without triggering a run on deposits. It would be really nice if we could do this while making a clean distinction between two completely different sets of firms, but that ship sailed a long time back.

So what are we supposed to do now? Should none of our leaders openly discuss something which is both very important and highly political (because it involves making hard choices about winners and losers and how to parcel out the pain)?

Are we really supposed to have these things decided behind closed doors? And if not, then the pressing need to hash these things out in a public forum rather than in a technocratic and oligarchic fashion is in serious tension with the idea that what a leader like Dodd says in public can move markets and possibly trigger a bank run. Some sort of reasonable balance between discretion and discussion is needed to best serve the public interest.

In reading Matt's post, I don't see any indication that he recognizes this dilemma.

[Wagster]

Von, you didn't get my previous comment.

You don't want the market to "fairly price" companies they don't have adequate information about, because that spreads the panic evenly over healthy and non-healthy banks. It might lead a bank that's just above the threshold to fall below it.

Yglesias is right. Don't speculate about nationalization until you're prepared to do something about it, and that won't be until after the stress test.

[now_what]

But they are nationalizaing banks now, despite what they might be saying. In fact its been going on for months, why so different now?

That's what I wondered earlier. Dodd said, "(I)t may be necessary to nationalize some banks for a short time". For a short time? Doesn't the government take over a bank or two for a short time just about every other Friday lately? Tape the offices off like a crime scene, walk the managers to the door and do an inventory of what is really in the vault?

Is that nationalization? Because that's not what it was ever called before. How is what Dodd is talking about different other than the size of the banks involved (meaning that it may take longer to sell them or pieces of them back into private hands)?

To me it just sounds like Dodd said the government will do what the government has done with bad banks for 70 years or so. What am I missing?

[mikkel]

I thought I'd just stop in to point out what the S&P said today:

"That could mean that the slowdown in lending is just an opening act, and a true credit crunch may yet take the stage," Azarchs warned.

Now that's food for thought. My opinion on this (and rumors in general) is that they only take down the companies that were eventually going to go down anyway. I love it how Dodd got blamed for IndyMac kicking the bucket. That was too rich considering they were the #1 on the watch list (well once Countrywide was bought) for years. Everyone knows BAC and Citi are toast, that Wells is precarious (due to the idiotic Wachovia purchase), GE is ghastly and JP Morgan may get out of this despite their best efforts to fail. The problem with the government interventions haven't been that they have (or not have) foreshadowed them, but that there is an ad hoc application. They just need to draw the line in the sand and stick to it.

[bobbyp]

Von,

Remember Reagan's funny remark about having just ordered the launching of our nuclear forces against the Sovient Union? Izz'at the same thing?

That was a real laugher at the time. Those were the good old days. A few trillion dollars still doesn't match up to world anihilation.

Conservatives really knew how to yuck it up then. Whatever happened?

[AHG]

Some commenters have hit on this a bit, but there are two issues that you are conflating a bit: scaring the markets and scaring account-holders. They are related, as you note, but by no means the same.

Yglesias was talking about preventing a run on solvent banks by nationalizing those that are insolvent and assuring the public that those not nationalized are not at risk. His solution is not really workable (I know the basics of how FDIC takeovers work and this many of this size really can't be done overnight given the resources of the agency), but would achieve his goal of preventing runs if the public buys into the government's message. In other words, if we could do this and the public could be convinced that their money was safe and the system wasn't at risk, there probably wouldn't be very many runs on stable institutions.

Your focus on the needs of the investor class to price in the possibility of nationalization, while laudatory, is a bit late at this point. The stock prices of Citi and BofA at closing tonight, (1.95) and (3.79) respectively, are just premiums on put options betting that the companies won't be nationalized. No one believes the companies have money, the bet is whether the government will wipe out shareholders in a nationalization or hand shareholders and subordinated debt holders a windfall by backing assets without taking ownership of the upside. The market's pricing on the possibility of simple government backing without liquidating shareholders has already shrunk to almost nothing. Casual investors should have gotten out of both of these firms long ago (though sadly, you're right that many certainly didn't).

Wells Fargo, sitting at about 11, is a slightly different story, but given the 2/3 drop in price since January, reality is setting in there as well.

[Neil the Ethical Werewolf]

There are a bunch of ways in which the perception that a bank is more likely to get nationalized can get it in trouble.

Suppose people are worried that Goldman might get nationalized (Goldman is currently thought to be solvent, but who really knows?) And suppose they know that Goldman has really big holdings of some particular asset. Under nationalization, that asset is probably going to be sold off in large quantities.

Now suppose you own some of that asset. You're going to be selling quickly to get out before Goldman dumps it. If lots of people do that, the price of the asset drops, screwing up Goldman's balance sheet and potentially pushing it into insolvency.

That's just one way. But in general, the perception that you're going to fail is not a good one for you. People are less likely to extend you loans, hold what you've been buying, or enter into mutually beneficial transactions where they could get screwed if you collapse.

[John Spragge]

von wrote: "...there's no satisfying way of punishing folks without shooting ourselves in the foot."

With all due respect, von, I think that boat has essentially sailed. The United States has developed a culture of punishment. Y'all have more of your population in jail than any other country. American media and popular culture has promoted the notion that you owe it to the victims of crime to severely punish offenders into a cultural cliché. You can, if you wish, argue that the managers of this catastrophe have done nothing wrong, or nothing legally punishable. But to apply a cost-benefit analysis to retribution for some pretty reckless behaviour with other people's money and at the same time maintain a prison system stuffed with millions of mostly poor and lower middle class offenders, that won't do.

[Happy Jack]

To me it just sounds like Dodd said the government will do what the government has done with bad banks for 70 years or so. What am I missing?

Just a guess, but I'd say branches in London and Tokyo, currency trading, derivatives, etc.

Oh, and when the FDIC usually takes over, they find another bank to take the assets. I'm at a loss as to who is big enough to handle Citi and BoA.

[Jason Kratz]

No offense but boo-freaking-hoo for the investors. Part of making an investment is risk. People should have gotten out of these a long time ago. If they didn't...well...part of the risk is losing all of your investment.

[von]

I'm confused (to say the least).

A number of commentators claim that Yglesias is primarily (or solely) concerned about protecting those who have deposits with the banks; thus, Dodd should shut up so that there is not a "run on the banks." If that's Yglesias' primary or sole concern, it makes sense only if the nationalization plans under discussion offer less protection than the FDIC.

A supurb way to create a run on even solven banks, however, is to do a suprise nationalization that reaults in less than the full FDIC protects. In the aftermath of such a suprise, the Government's word that there will be no more surprise nationalizations will be worth precisely zero.

OTOH, even assuming that nationalization results in full FDIC protectioins, as it should, it still makes sense to talk about nationalization before doing it. Once can justify investors losing their shirt, but one can't justify the cascade effect on companies or individuals who maintain deposits above the FDIC limits.

Look, I sincerely hope that Sen. Dodd gets defeated when he's next up for election. But Sen. Dodd knows exponentially more about the bankking system you, me, or Yglesias. Stop presuming that he's an idiot and that y'all have figured out some secret truth that has eluded everyone else.

[von]

The more I consider arguments by J. Michael and others, the worse the arguments look. One main goal of nationalization is to avoid the cascade effects on deposits not otherwise protected by the FDIC or other insurance. You do that by talking up a nationalization plan in which protects such depositors (and others doing business with the bank).* Without Senator Dodd or others plugging this plan, these folks may rightly fear that they can't do business with Citi (or BOA), causing further harm.

In other words, J. Michael's framinig reveals further problems with "silence, then action".

The best way to do a nationalization is to be absolutely transparent about the process all the way through. Acting like a philosopher-king-cum-ninja is not the way to handle a banking crisis in a democracy.

Finally, to echo Hilzoy: Any solution needs to create incentives that punish high-risk, short term thinking. That may include some sackings, but the more important changes are structural .... and we don't want to get into a situation in which we are so punitive that we lose the best talent. (Remember, these folks applied their talents to the rules in place; there is good reason that different rules will generate a different outcome.)

*I want to stress that this category includes many more businesses and individuals than depositors; indeed, the deposit side may be the least important aspect of this.

[Neil the Ethical Werewolf]

In the aftermath of such a suprise, the Government's word that there will be no more surprise nationalizations will be worth precisely zero.

Sure, but their word that Wells Fargo has assets exceeding its liabilities even after marking to market will be worth plenty.

[Lewis Carroll]

"and we don't want to get into a situation in which we are so punitive that we lose the best talent"

I'm mostly a lurker, but if I could ask one question it would be: Where is the empirical evidence for these people being the *best talent*? At least in terms of having a talent for doing what they're supposed to be doing, namely producing real value and true profits for their shareholders.

I've seen that talent from, say Warren Buffett, but from very few others in the FIRE sector.

[Anarch]

von: Compare the following two scenarios:

1) Government says "We are now looking at bank X". Some time later, they say "We are no longer looking at bank X, it is solvent."

2) Government says nothing. Some time later, they say "We have looked at bank X, it is solvent."

[Then, of course, repeat for insolvency.]

Is it your contention that the latter will be more likely to induce a panic than the former? Because in every similar example with which I'm familiar, it's the former that will cause the panic. The mere fact that the government is known to be looking at a bank will cause some people to panic, even if there's no there there. It's the nature of the beast.

Also, I'm a little taken aback by your invocation of "philosopher-kings-cum-ninjas". The ninjas I get, but is the implication that you'd like to throw the process open to the republic of general investors? Because that seems foolhardy to me: the entire point of this process is that general investors lack the expertise to determine whether banks are solvent or not. It's not democratic and it's not intended to be; if the democratic approach would have worked, we wouldn't be in this mess in the first place.

[rook]

Judging the wisdom of Dodd's comments requires a bunch of information nobody has. Specifically:

1. Would the banks be nationalized without Dodd's comments?
2. Would the banks be nationalized with Dodd's comments?

If one is no and two is yes, then Dodd is a blithering idiot. If they're both no, Dodd is doing some needless damage to the economy and these banks specifically. If they're both yes or somehow one is yes and two is no (there's no rationale for that, but you never know), then there's probably some benefit to making investors feel like they'll get some form of notice ahead of nationalization. So all we have to do is answer those two questions, and we should be all set.

The fact that Dodd probably knows all this makes me think the probability of (additional) nationalization must be pretty high. Tomorrow, I'll be making sure none of my investments include banks and putting my money in a safe in my house. I know the goverment will almost definitely cover my deposits, but they don't call it a safe for nothin!

[von]

Sure, but their word that Wells Fargo has assets exceeding its liabilities even after marking to market will be worth plenty.

The clear cases aren't a concern. There will be many firms that are technically insolvent at present, but are likely to survive without nationalization. How do we take the government's word as to those?

Anarch, your options one and two aren't on the table at the moment. The cat is already out of the bag (via TARP and required disclosures) which banks are sickly and which are not.

Rook, you're "blithering idiot" comment suggests that you don't see a lot of situations that involve risk. But your bottom-line analysis is probably sound (save for the safe idea): I think Dodd, and the market as a whole, believes some form of nationalization is more likely than not. Hence, the low (but not zero) value of the relevant stocks.

[von]

You're = your in my comment to Rook.

[Anarch]

Anarch, your options one and two aren't on the table at the moment. The cat is already out of the bag (via TARP and required disclosures) which banks are sickly and which are not.

I know, I was trying to simplify the conversation. That doesn't answer my question, though: how are you figuring that the market won't panic when given the information that the government is considering nationalization on the following banks, as opposed to the government just nationalizing them?

I'd understand your point better if this really were an issue where the wisdom of the market were relevant; but the entire point of the crisis is that the market got this wrong, and will likely to continue to do so. The whole point is that the details are so arcane that we need... well, I'm loathe to call them "philosopher-kings", perhaps "beneficient fiscal despots", to make those valuations on our behalf.

Or, if you'd like this even simpler: the market f***ed this up for almost a decade. What makes you think they're going to get it right now?

[rook]

You're = your in my comment to Rook.
Phew!

Rook, you're "blithering idiot" comment suggests that you don't see a lot of situations that involve risk.

My 'blithering idiot' comment was tongue-in-cheek hypothetical Monday-morning quarterbacking. To keep things symmetrical, I should have finished with a fourth category: If one is yes and two is no, Dodd is a flippin genius. I own a small business, so risk and I are well-acquainted. I was arguing that the wisdom of his statements is dependent upon the probability of each scenario (and for each bank). Since we don't know that, we can't know if it was a good or bad idea.