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Financial Times, February 21, 2009 column


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On Wall Street

The game is up: within the next few weeks, if not days, the US government will have to step in and nationalise one or more banks.

The likely candidates to the dubious honour of being owned by Washington Inc can be found at the end of a sad trail of credit losses, management mishaps and share price collapses.

Come on down, Citigroup, Bank of America and a motley crew of regional and community banks. Barack Obama, US president, will have to draw on his vast oratorical skills to avoid using the N-word but make no mistake: the authorities are going in.

Why am I so sure? Because, as the US banking guy for the Financial Times, for the past year I have had a ringside seat to the demise of the global banking sector.

The destructive blend of ineptitude, myopia and greed that led to the crisis has made it impossible for piecemeal solutions to work.

When commentators warn that a failure by the latest US rescue plan would lead to a "Japanisation" of the financial sector, they are missing the point. It is too late to worry about banks turning into "zombies" - they already are. Crushed under a pile of toxic assets, paralysed by wafer-thin capital cushions and deserted by fearful investors, once-mighty institutions such as Citi and BofA are barely able to perform basic functions such as lending and underwriting.

In fact, the only reason they have not joined Lehman Brothers, Bear Stearns and Washington Mutual on the financial scrapheap is because taxpayers have propped them up with more than $500bn in cash injections and guarantees.

At this stage, some form of nationalisation is both a political and financial imperative. On the political front, the concept has won backing from unexpected quarters. This newspaper's account of Alan Greenspan's conversion from icon of free-market liberalism to proponent of a temporary nationalisation was mind-boggling.

To couple that with a similar U-turn by Lindsey Graham, a Republican senator who has built a political career out of his love of small government, was just astonishing.

The reality is that even the right wing of the political spectrum realises that banks cannot be left to their own devices while in receipt of federal funds.

From a financial perspective, nationalisation of one or more banks - followed by a public offering once they are cleaned up - need not be a socialist nightmare or, in the words of a memory-challenged American banker, "an idea for fools and Europeans" (how about AIG, Fannie, Freddie and IndyMac?).

Government control would solve two key problems that have haunted policymakers since the start of the turmoil: pricing of toxic assets and banks' unwillingness to lend.

Unlike current management, who live in fear of further writedowns, Treasury would have little to lose in marking troubled assets sharply lower. That, in turn, would make it easier to sell them to private equity and hedge fund investors, or run them off.

The reason why Citi, BofA and others have failed to unburden their balance sheets is that management have an incentive to hope against all hopes that markets will get better. A similar paralysis has affected lending decisions. Scared by the prospect of new defaults by maxed-out consumers and businesses, lenders have shut up shop, thus exacerbating the economic hardship they are trying to escape. By contrast, a hands-on approach by government, coupled with its higher tolerance of losses, would direct funds where the economy needs them.

The main question for the administration is how to nationalise stricken banks.

That is where the much-maligned "Geithner plan" offers a solution. For all its lack of detail, Mr Geithner's outline does say to subject banks to a "stress test".

Wall Street executives have scoffed at the idea, saying regulators constantly test their financial health. Yet, setting a new hurdle gives the authorities an objective-looking yardstick to sanction a takeover.

Banks will not like it - and Citi, for one, is already agitating for yet another bail-out without nationalisation. But as the financial chain comes under unprecedented strain, the time has come to take out its weakest links.


Copyright The Financial Times Ltd 2009.




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