Over at US News, Rick Newman has an article on why bank nationalization is allegedly such a scary prospect. Now, let me start by saying that it is scary. Not because it’s ‘nationalization’ and that’s somehow inherently scary. But because we’re in a midst of an historic financial crisis — and it’s global. There are so many moving parts that the results of any potential actions are inherently unpredictable. And the stakes are very high. (The biggest fear I have is that the take over of a few big banks could start a cascade effect with runs on others, though I don’t have the specialized knowledge to have a good sense of how likely that is, what steps you’d take prevent it.)
But one point in Newman’s list stuck out at me — that nationalization would ‘vaporize’ a lot of wealth.
This is why the markets freak out every time there’s a rumor, or a rumor of a rumor, about nationalization. If the government took over a bank, public shares would suddenly be worthless and shareholders would lose everything. With Citi and Bank of America shares down more than 90 percent over the last 12 months, many shareholders have already lost a fortune. But there’s still a chance they’ll get some of it back if the bank recovers. That potential upside would disappear if the feds stepped in.
Even worse, the banks’ bondholders and other creditors could lose a bundle too. Same with depositors and institutional customers whose account balances exceed the amount guaranteed by the FDIC. To prevent a panic, the government would probably cover those stakeholders up to a certain level – with taxpayers footing the bill once again.
Now, this is a key point. I’m frequently told that the whole issue of wiping out the shareholders is a non-issue, or an overblown issue, since the shareholders are already basically wiped out, having lost like 90% or 95% of their investment on some of the big bank stocks. But this is the point — if the US government takes responsibility for keeping Citigroup on life support and nursing it back to health over 5 years or so at massive taxpayer expense, the value of that stock is going to go way up. That’s especially the case since the equity the government is getting doesn’t come close to market value for the money being invested. So yes, it’s scary how many people could ‘lose a bundle’, unless you come to grips with the fact that that bundle has already been lost and that the only thing preventing them from coming to grips with that fact is the assumption that the taxpayers will come in and make all those folks whole.
As Joe Stiglitz says (and many other do too) it really is a zero sum. How much do the investors pay for and how much do the taxpayers pay for?
