Nationalization of American Banks – Stop The Presses.

The more we hear that nationalizing banks is being contemplated by our elected officials, the more it will destabilize our financial system. Bank stocks like Citigroup and Bank of America, which were rumored to be on the short list of banks that could be nationalized, have been decimated. This kind of irresponsible commentary is having a self-fulfilling prophecy. Another bogus line of thinking is that since these banks received TARP money, the government is in effect running these institutions resulting in a de facto nationalization. While there are certain strings attached to banks receiving this money, like putting a cap on salaries and bonuses, this is a far cry from nationalization where the Government actually takes over running the entire bank. We hope the government is smart enough not to encumber Citigroup’s day-to-day activities after taking control of 36% of its common stock. If you think a lot of these banks have been run badly, wait to you see what the government will do.

Bill Seidman, who was Chairman of the FDIC and head of the Resolution Trust Corporation that took over many of the failed banks during the 1980s savings and loan crises, is advocating the same approach today. He makes nationalization sound easy. However, Citigroup and Bank of America are not small savings and loan organizations. We are talking about organizations that are a great deal larger and more complicated than the savings and loans that were rescued. Do you really think the Government can run a trading desk or a credit-default-swap operation? More importantly, how is the government going to handle the so-called toxic assets? Currently, there appears to be no active market for these securities. This is the major fallacy regarding nationalization. It would take the government a long time to get rid of these toxic assets in a prudent way, and we are assuming that the government has the capacity to get reasonable prices for these assets.

This is the crux of the problem. Many of the underlying mortgage pools that support these securitized obligations are paying off at rate which is not being adequately reflected in the current market value of these securities. If the current market prices for these securities are understated, why are we forcing the banks to use mark-to-market accounting? A better solution would be to modify the mark-to-market accounting convention that was implemented at the end of 2007. If it is going to take a while for the government to sell these toxic assets, why not give the banks an opportunity over a few years, either to sell these assets and/or amortize these losses based on an average market price during each year. Aren’t these banks in a better position to deal with these assets than the government? If the banks have more time to unload these assets, there could be less supply for sale at any given time. This, combined with the potential for higher prices due to improved market conditions, may provide the banks an opportunity to capture more favorable prices for these securities in the future.

Mark-to-market accounting is unnecessarily impairing the bank’s balance sheets by forcing banks to write down all these toxic assets every quarter based on the last market price. This is analogous to someone on your block selling a house at very distressed price because they need to raise money quickly. In effect, the value of your house has also been marked down. The banks have accumulated these assets over many years, and the accounting convention that was used for many years has changed. Since these toxic assets were not very liquid, the banks have historically used a market-model-approach to value these securities. The concern about market-model-accounting is the potential that banks may overstate the real market value of these distressed assets. Investors need to be confident that there is transparency, and that these assets are properly valued. However, due to mark-to-market accounting, coupled with the troubled state of the economy, the banks are currently dealing with target prices for these illiquid assets that are constantly moving and shrinking. Thus, bank managements continue to be in a quandary about forecasting and assessing their capital requirements, which is having a negative impact on lending. This uncertainty is causing a circuitous process as banks curtail lending, the economy is negatively affected, which in turn adversely affects lending and the price of bank stocks. This vicious cycle needs to be broken in order to stimulate economic growth.

While we should not completely eliminate mark-to-mark accounting, it needs to be modified in order to factor in illiquid market conditions. If we do not make this accounting adjustment, the cost to the Government and ultimately the taxpayers will continue to increase as more and more capital is required to make these troubled banks solvent.