Nouriel Roubini floats a novel theory to explain Tim Geithner’s disastrous speech the other day: He actually knows what he’s doing.
The savvy Geithner, this theory goes, has determined that seizing Citigroup (C) and Bank of America (BAC) now would trigger a run on the bank at JP Morgan (JPM) and Wells Fargo (WFC)–thus forcing the immediate seizure of those giants, too. JPM and WFC are also insolvent, so this wouldn’t be irrational, but Geithner and his bosses might get blamed for destroying them.
In 6-12 months, meanwhile, the market will gradually have realised that JPM and WFC are insolvent, so nationalization will no longer be a startling alternative (and Obama and Geithner won’t get blamed). So, wait a while, and let the market do the unpleasant work for you. In the meantime, continue with Hail Mary Plan A and hope it works. And if it doesn’t, revert to the then-more-politically-palatable Plan B.
Nouriel Roubini: So why is the US government temporizing and avoiding doing the right thing, i.e. take over the insolvent banks? There are two reasons.
First, there is still some small hope and a small probability that the economy will recover sooner than expected, that expected credit losses will be smaller than expected and that the current approach of recapping the banks and somehow working out the bad assets will work in due time.
Second, taking over the banks – call is nationalization or, in a more politically correct way, “receivership” – is a radical action that requires most banks be clearly beyond pale and insolvent to be undertaken. Today Citi and Bank of America clearly look like near-insolvent and ready to be taken over but JPMorgan and Wells Fargo do not yet. But with the sharp rise in delinquencies and charge-off rates that we are experiencing now on mortgages, commercial real estate and consumer credit in a matter of six to twelve months even JPMorgan and Wells will likely look as near-insolvent (as suggested by Chris Whalen, one of the leading independent analysts of the banking system).
Thus, if the government were to take over only Citi and Bank of America today (and wipe out common and preferred shareholders and also force unsecured creditors to take a haircut) a panic may ensue for other banks and the Lehman fallout that resulted from having unsecured creditors taking losses on their bonds will be repeated again. Instead if, as likely, the current fudging strategy – of temporizing and hoping that things will improve for the economy and the banks – does not work and in 6-12 months most banks (the major four and the a good part of the remaining regional banks) all look like clearly insolvent you can then take them all over, wipe out common shareholders and preferred shareholders and even force unsecured creditors to accept losses ( in the form of a conversion of debt into equity and/or haircut on the face value of their bond claims) as the losses will be so large that not treating such unsecured creditors would be fiscally too expensive.
So, the current strategy – Plan A – may not work and the Plan B (or better Plan N for nationalization) may end up the way to go later this year. Wasting another 6-12 months to do the right thing may be a mistake but the political constrains facing the new administration – and the remaining small probability that the current strategy may by some miracle or luck work – suggest that Plan A should be first exhausted before there is a move to Plan N. Wasting another 6-12 months may risk turning a U-shaped recession into an L-shaped near depression but currently Plan N is not yet politically feasible.