As a disclaimer I will point out that I am in favor of nationalization and believe that it will be what happens eventually because we will have no choice in the matter. That being said, I believe one of the biggest aspects of what is being left out of the discussion are why nationalization is probably the weapon of last resort.
The person who should know best of the situation is the current head of the FDIC, Sheila Bair.
Who is Sheila C. Bair? She is the current head of the Federal Deposit Insurance Corporation and has been in this position since 2006.
While being hired by Bush she was a dissenting voice in the administration warning about the coming crisis of subprime loans, insisting on banks to pay their preminums in case of a crisis, and being a loud voice against the bank bailout because she believed it did not do enough to protect home owners. Right now she is making the argument, much like Krugman and Roubini, that there should be no such thing as 'too big to fail'.
Which makes her views on nationalization even more interesting. In her testimony before the Committee on Banking, Housing, and Urban Affairs she presents an argument for the problems with nationalizating banks under her current authority.
The problems of supervising large, complex financial institutions are compounded by the absence of procedures and structures to effectively resolve them in an orderly fashion when they end up in severe financial trouble. Unlike the clearly defined and proven statutory powers that exist for resolving insured depository institutions, the current bankruptcy framework available to resolve large complex non-bank financial entities and financial holding companies was not designed to protect the stability of the financial system. This is important because, in the current crisis, bank holding companies and large non-bank entities have come to depend on the banks within the organizations as a source of strength. Where previously the holding company served as a source of strength to the insured institution, these entities now often rely on a subsidiary depository institution for funding and liquidity, but carry on many systemically important activities outside of the bank that are managed at a holding company level or non-bank affiliate level.
While the depository institution could be resolved under existing authorities, the resolution would cause the holding company to fail and its activities would be unwound through the normal corporate bankruptcy process. Without a system that provides for the orderly resolution of activities outside of the depository institution, the failure of a systemically important holding company or non-bank financial entity will create additional instability as claims outside the depository institution become completely illiquid under the current system.
In the case of a bank holding company, the FDIC has the authority to take control of only the failing banking subsidiary, protecting the insured depositors. However, many of the essential services in other portions of the holding company are left outside of the FDIC's control, making it difficult to operate the bank and impossible to continue funding the organization's activities that are outside the bank. In such a situation, where the holding company structure includes many bank and non-bank subsidiaries, taking control of just the bank is not a practical solution.
She breaks this down even further during her remarks to the Institute of International Bankers
Many have pointed to the FDIC's model of resolving failed banks as a possible solution. I believe the FDIC model is tried and true. I take great pride in the fact that bank closings have gone smoothly. And we've been able to return failed institutions to private hands, despite the poor market for distressed financial assets.
But clearly, there would be practical problems if we had to use our resolution process for a large, internationally active institution. First, we do not have authority to resolve financial holding companies. Our powers extend only to federally insured banks.
This is a geniune problem. Bank holding companies are not your grandfather's, or even your father's, bank. While banking does go on there they are many other business groups attached to the primary bank that is used to capitalize the others. The FDIC only has authority to seize the banking property that is insured by the FDIC.
What in the banking section is insured by the FDIC?
FDIC-Insured
Checking Accounts (including money market deposit accounts)
Savings Accounts (including passbook accounts)
Certificates of Deposit
So let's take a look at what one of the bank holding companies, in this case Citigroup, holds.
Citigroup has four major segments in its business group. There is consumer banking, global cards, Institutional Clients Groups (which covers investment banking, private equity, and real estate), and Global Management (which covers private banks, retirement services, and banking services).
Out of all of these groups the FDIC only has jurisdiction over counsumer banking, which means it can only take care of Citibank. The rest of the company is off limits to the FDIC.
Which goes into another point. Citibank is an international company. It is in business in over 107 different countries and has over 200 million customers worldwide. This makes Citigroup one of the biggest financial institutions on earth.
Sheila Bair explains why this is a problem:
Today, a crisis involving an international company is resolved by domestic laws, in separate countries. The problems that can arise are obvious.
The national legal processes are inconsistent and too slow. The more complex the institution, the more inadequate most national laws become. And as a result, countries have relied on ring fencing and protection of their 'national' banks. So without burden-sharing, you can't stop asset ring-fencing.
Let me go over a few of the problems that this can cause.
After legal intervention, continuity of essential banking operations is virtually impossible under most national laws. The U.S. does have an advantage here, except with financial groups.
Most laws have virtually no provisions to deal specifically with cross-border banking crises. No country has adequate laws to resolve problems in international financial groups that operate through separate legal entities in different jurisdictions. Indeed, few countries even have the tools for resolving domestic financial groups.
Many of the standard ways for dealing with failed banks – such as our bridge bank – will probably not work across borders. Simply put: other countries have no duty to recognize a bridge bank or its actions under U.S. law. Cross-country differences in close-out netting, the unwinding of financial transactions, and the enforceability of secured parties' rights to collateral may add to increased uncertainty. In this environment, ring-fencing – also known as every man for himself – may simply be the only rational response.
The problem with winding down international conglomerates is the fact that they are international and therefore operate by different financial laws internationally. By our banks being tied up so much in the bank holding companies it makes them harder to take over as well in terms of international payments and rules.
I'll once again reiterate that I am for nationalization. I think it is the least shitty option out of many. And there maybe valid objections to what Bair has to say here. But I think it is worth examining the problems with nationalization as it is concieved of this moment. And I also think it is worth the time and effort to examine ways in which we can get around these situations to make nationalization a much more safe bet to take.