I’m not sure why I bothered writing my blog entry on nationalization last night, since Paul Krugman wrote essentially the exact same thing, only more concisely and with much greater elegance. Still, I did get some interesting comments, both on the blog and by email.
John Hempton accuses Krugman of "publishing voodoo maths", which is way too strong. Hempton’s point is that if a cashflow-positive but insolvent bank keeps on operating for long enough, then eventually it won’t be insolvent any more. Well, yes, but what makes the bank cashflow-positive? As Steve Waldman asked in an email to me:
Suppose a bank is solvent if one considers as an asset the value of a stream of cash-flows that exists solely due to costly government action. Governments issue costly guarantees to prevent runs and keep insolvent banks liquid, and that serve (along with direct central bank lending) to reduce banks’ funding costs to far below what the market would require, creating net cash flows to the bank. Is that asset rightly the property of the bank — its existing shareholders and managers — or does the asset really belong to taxpayers?
Another correspondent writes to say, plausibly enough, that the banking system is in the weird place of being fully aware that it’s in denial:
There is still massive implicit accounting fraud going on. Senior management of all of these firms are completely aware that they are carrying bad assets on their books at inflated marks. It’s happening virtually everywhere, including in hedge fund and private equity land.
The bad marks pervade everything. Nobody believes anyone’s numbers — because each person knows HE is lying, and so therefore he knows that everyone else is lying.
I remain absolutely convinced that one of the key reasons that liquidity has utterly vanished for a lot of these assets is that the people who own them don’t actually WANT them to trade. If they trade, you see what they’re really worth, and you have to mark them accurately or you really are committing fraud, and then it’s clear that you’re insolvent and you go kablooey. So best just to sit on the cancer and not talk about it.
Most helpfully of all, commenter OneEyedMan actually came up with at least one good reason not to nationalize. I still think that nationalization is the only way to go. But I’m now beginning to understand where the non-knee-jerk opposition to nationalization is coming from:
Nationalization deprives us of the ability to see a price on bank stock. That’s a real and valuable measure that along with CDS prices allows us to see when and if our banking system is exiting this crisis. Once everything has a government guarantee and/or the government as the sole equity owner we’ll loose that. Prices carry a lot of information, we should use them and abandon them with great hesitation.
OneEyedMan also came up with another possible solution to the problem of insolvent banks: legislation creating a new form of bankruptcy, which would allow some kind of debt-to-equity cramdown. I suspect the practical obstacles to creating a workable form of legislation along these lines might be insurmountable, but it might be worth a try.
One problem with it, however, is that most of the investors in unsecured bank debt are not only unwilling but also unable to invest in bank equity. When they are forced to sell their bonds into a market with precious few buyers, all that valuable price information would carry rather more information than we wanted: specifically, that pretty much every bank in the system was insolvent. Which is not the desired outcome.