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Nationalizing zombie banks to clean up banking
By Nouriel Roubini |
February 20, 2009, Friday
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A YEAR ago, I predicted that the losses of US financial institutions would reach at least US$1 trillion and possibly go as high as US$2 trillion.
As I pointed out, with the United States and global economy sliding into a severe recession, bank losses would extend well beyond sub-prime mortgages to include sub-prime, near-prime, and prime mortgages; commercial real estate; credit cards, auto loans, and student loans; industrial and commercial loans; corporate bonds; sovereign bonds and state and local government bonds; and losses on all of the assets that securitized such loans.
Indeed, since then, the write-downs by US banks have already passed the US$1 trillion mark (my floor estimate of losses), and institutions such as the IMF and Goldman Sachs now predict losses of more than US$2 trillion.
But if you think that the US$2 trillion figure is already huge, the latest estimates by my research consultancy RGE Monitor suggest that total losses on loans made by US financial firms and the fall in the market value of the assets they hold (things like mortgage-backed securities) will peak at about US$3.6 trillion.
US banks and broker dealers are exposed to about half of this figure, or US$1.8 trillion; the rest is borne by other financial institutions in the US and abroad.
The capital backing the banks' assets was only US$1.4 trillion last fall, leaving the US banking system some US$400 million in the hole, or close to zero even after the government and private-sector recapitalization of such banks.
So, the US banking system is effectively insolvent in the aggregate; most of the British banking system looks insolvent, too, as do many continental European banks.
There are four basic approaches to cleaning up a banking system that is facing a systemic crisis: recapitalization of the banks, together with a purchase of their toxic assets by a government "bad bank"; recapitalization, together with government guarantees -after a first loss by the banks -of the toxic assets; private purchase of toxic assets with a government guarantee (the current US government plan); and outright nationalization (call it "government receivership" if you don't like the N-word) of insolvent banks and their resale to the private sector after being cleaned.
Of the four options, the first three have serious flaws. Thus, paradoxically nationalization may be a more market-friendly solution: it wipes out common and preferred shareholders of clearly insolvent institutions, and possibly unsecured creditors if the insolvency is too large, while providing a fair upside to the taxpayer.
Indeed, the problem has now grown larger, because the current approach has led weak banks to take over even weaker banks. Merging zombie banks is like drunks trying to help each other stand up. With nationalization, the government can break up these financial monstrosities and sell them to private investors as smaller good banks.
Whereas Sweden adopted this approach successfully during its banking crisis in the early 1990s, the current US and British approach may end up producing Japanese-style zombie banks -never properly restructured and perpetuating a credit freeze.
(The author is professor of economics at New York University. Copyright: Project Syndicate, 2008. www.project-syndicate.org.)
As I pointed out, with the United States and global economy sliding into a severe recession, bank losses would extend well beyond sub-prime mortgages to include sub-prime, near-prime, and prime mortgages; commercial real estate; credit cards, auto loans, and student loans; industrial and commercial loans; corporate bonds; sovereign bonds and state and local government bonds; and losses on all of the assets that securitized such loans.
Indeed, since then, the write-downs by US banks have already passed the US$1 trillion mark (my floor estimate of losses), and institutions such as the IMF and Goldman Sachs now predict losses of more than US$2 trillion.
But if you think that the US$2 trillion figure is already huge, the latest estimates by my research consultancy RGE Monitor suggest that total losses on loans made by US financial firms and the fall in the market value of the assets they hold (things like mortgage-backed securities) will peak at about US$3.6 trillion.
US banks and broker dealers are exposed to about half of this figure, or US$1.8 trillion; the rest is borne by other financial institutions in the US and abroad.
The capital backing the banks' assets was only US$1.4 trillion last fall, leaving the US banking system some US$400 million in the hole, or close to zero even after the government and private-sector recapitalization of such banks.
So, the US banking system is effectively insolvent in the aggregate; most of the British banking system looks insolvent, too, as do many continental European banks.
There are four basic approaches to cleaning up a banking system that is facing a systemic crisis: recapitalization of the banks, together with a purchase of their toxic assets by a government "bad bank"; recapitalization, together with government guarantees -after a first loss by the banks -of the toxic assets; private purchase of toxic assets with a government guarantee (the current US government plan); and outright nationalization (call it "government receivership" if you don't like the N-word) of insolvent banks and their resale to the private sector after being cleaned.
Of the four options, the first three have serious flaws. Thus, paradoxically nationalization may be a more market-friendly solution: it wipes out common and preferred shareholders of clearly insolvent institutions, and possibly unsecured creditors if the insolvency is too large, while providing a fair upside to the taxpayer.
Indeed, the problem has now grown larger, because the current approach has led weak banks to take over even weaker banks. Merging zombie banks is like drunks trying to help each other stand up. With nationalization, the government can break up these financial monstrosities and sell them to private investors as smaller good banks.
Whereas Sweden adopted this approach successfully during its banking crisis in the early 1990s, the current US and British approach may end up producing Japanese-style zombie banks -never properly restructured and perpetuating a credit freeze.
(The author is professor of economics at New York University. Copyright: Project Syndicate, 2008. www.project-syndicate.org.)
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