Be it named "preprivatization," "receivership," "nationalization," etc. I recognize the fear of an ad hoc rescue plan for the banks that results in short term government control. If the government takes over Citigroup, for example, and wipes the shareholders out, other bank shares will plummet (making them perversely more likely to be taken over especially given the decision to use Total Common Equity and not Tier 1 capital as the benchmark measure for the stress test) because they know if they get caught holding shares they're going to lose whatever equity they have. Hence, it's not so much the shareholders of the banks that are currently the biggest worry (anyone who owns Citi or BoA right now are speculators, and it's only roughly 40b in equity at most between them we're talking about) but instead the investors into other publicly traded banks that might be taken over and hence further shake confidence in the banking industry. At the same time, an effective temporary receivership strategy is the only way we're going to get both a full accounting and a permanent solution to the financial crisis-
- and it is the only way outside of the government making guarantees to the banks to give the banks carte blanche on government credit. Giving money piecemeal as we've been doing, and on a case by case basis, means that there is no faith whatsoever in the system because no one knows what the Government will do, outside of not letting some massive banks fail. Even then that doesn't inspire confidence, it just inspires slightly less fear.
So why not take control the way a hostile takeover would? These banks already have so little equity that they would fail the stress test, so it's not as if it would be that expensive, and it would be pumping money into the market by cashing out current investors, while still controlling the bank and doing exactly what's needed to remake them as highly capitalized solvent entities via the seperation of toxic assets to a new giant government bad bank owned entirely by the government and deconstructing the megabanks like Citi into smaller banks that are not "too big to fail" and divested of their non-commercial bank divisions which themselves would become new, powerfully capitalized, entities. Via stock dispersal, the government and shareholders will come out with exactly the same proportion of equity in the new ventures. Those new ventures will be much more agile and able to act quickly, and their highly capitalized nature and government backing would inspire strong confidence in the market. Further, given that we're not wiping out shareholders, or even diluting them, the plan can be utilized on a bank by bank basis that allows quicker, more targeted action without spurring more collapses of confidence in other areas of the financial sector.
I realize that there are several significant issues of moral hazard and unintended consequences with this plan. As I said above, the current stockholders of the most clearly insolvent banks are largely speculators and they're not the best people to buy out. The conceivably would turn around and buy into other weak banks they expect to be nationalized in order to double up their buyout from the government. Further, if the government owns, as an example, 65% of a bank and it's going to create several solvent banks that are expected to make money as the economy improves, and those new entities are much less a risk than other investments so long as they're under the wing of the government, there's no doubt that the remaining publicly owned stock would quickly inflate in value in an unhealthy manner. These dual problems must be dealt with via a freeze on trading of the stock for so long as these new public companies are controlled by the government, which would solve the second problem and ameliorate the effects first. It also allows the government to recover the money it used to buy up the majority shares it required and the money that it will lose on the nonperforming assets in the new Naughty Securities Bank. It also would unwind a great deal of credit default swaps in an efficient manner that are part of the cause of the credit crunch, and ensure that the new agencies (with the exception of the new Swap Insurance Co. that will have renegotiated swaps based upon accurate valuations of the assets insured) are free of those obligations and counterparty risk without exposing the original banks partners to the sudden shock of counterparty risk.
That's the biggest problem I see, but there are others. For example, any control run under the auspices of the government will almost certainly include clawback measures for late in the day bonuses and golden parachutes for soon to be fired executives, as well as almost certain unemployment for many boards of director members and corporate officers. As in any hostile takeover, the board and executives would have a strong incentive to use all the considerable powers of their position to stymie such a takeover, via poison pills and changes in the articles of incorporation etc. While it's unlikely that they could stop the government from a standard hostile takeover, they could cause unacceptable delays and increase the cost to the government significantly. To avoid this, it is imperative that any such plan include the option for the government to take control of a company via fiat and the infusion of capital into the company that would be paid for by giving the government a controlling share of stock. Along with congressional legislation authorizing fast moving shareholder lawsuits against recalcitrant board members and executives when this end run is required that also contains strong canons of construction that are explicitly pro-stockholder, this provides a strong disincentive to try to fight off the government action.
Lastly, the issue of when the government relinquishes a controlling interest in the bank also needs to be answered. While this is likely not a major problem, it would be valuable to have a provision that gives the treasury supervisory control of the new banks until they deem fit. At the time this occurs the bank is turned over to a provisional Board of Directors and the Corporate Officers who have been appointed by the government to handle the transition and who may be kept on if both they and the board wish. When this happens, the government will sell a share of its common stock as necessary to reduce their investment in the bank to a non-controlling interest. This creates a speedy and transparent return to the private market, while retaining a significant government interest in the company in order to safeguard the taxpayer's interest against a reversion to bad behavior. Over time this stock will be sold off and the government will eventually divest itself of both ownership and shareholder influence in a controlled and steady manner not subject to the vagaries of the market.
So, why won't this work? I'm guessing there has to be a reason, because otherwise we'd be talking about this. I'm not that smart, nor do I know enough about economics or finance to have been the first person to come up with this. So I clearly missed something, but it's not in the related to the ability of congress to do this. Even the breakup of previously large dominant banks would probably be accepted fairly easily given the legislation in the plan won't affect future activity once the government is no longer invested, and we'll have significantly stronger regulatory regimes by that time. Perhaps the only question not yet answered is whether stockholders would part with enough current common stock, which I simply don't have enough knowledge to predict with even the faintest chance of accuracy.
