Wednesday, March 25, 2009

Nationalization is Not a Viable Option

Kevin Drum asks:

What would it take to nationalize an outfit like Citigroup? What are the likely legal, financial, diplomatic, and operational issues that would have to be resolved? It would be a real public service if someone with a credible background in this stuff could lay out the details in a way that's understandable for all the rest of us.
I don't have nearly enough time to lay out all the legal obstacles to nationalizing a bank like Citigroup, which would require several weeks, if not months, of legal work. But here's one major legal issue: investment rights under Bilateral Investment Treaties (BITs) and some multilateral treaties such as NAFTA. For example, Article 1110 of NAFTA (which is representative) provides:

1. No Party may directly or indirectly nationalize or expropriate an investment of an investor of another Party in its territory or take a measure tantamount to nationalization or expropriation of such an investment ("expropriation"), except:

    (a) for a public purpose;

    (b) on a non-discriminatory basis;

    (c) in accordance with due process of law and Article 1105(1); and

    (d) on payment of compensation in accordance with paragraphs 2 through 6.

2. Compensation shall be equivalent to the fair market value of the expropriated investment immediately before the expropriation took place ("date of expropriation"), and shall not reflect any change in value occurring because the intended expropriation had become known earlier. Valuation criteria shall include going concern value, asset value including declared tax value of tangible property, and other criteria, as appropriate, to determine fair market value.

3. Compensation shall be paid without delay and be fully realizable.

The disputes over valuations of Citi's equity and debt securities would be endless, fraught with uncertainty, and potentially very expensive for the government. What's more, claims under Article 1110 of NAFTA (and similar claims under some BITs) can be brought directly by private investors. This is just one of the seemingly endless legal obstacles to nationalizing an international financial institution like Citigroup, which has operations in over 100 countries. The legal issues alone would immediately create so much uncertainty that international financial markets would be thrown into chaos. What the blogosphere doesn't seem to realize is that nationalization is simply not a viable option. It's literally not on the table.


Ilya said...

Yes, that is precisely the point disregarded by the blogosphere. We are not in some kind of abstract Paul Krugman economic universe: we are firmly in the realm of political economy (subject to, inter alia, Congressional hysteria and, as you point out, legal contraints). Nationalisation is not an option in this context.

Geithner's plan is certainly not perfect. More detail will be necessary to arrive at a final judgement. However, insofar as price discovery is concerned, it is a step in the right direction.

septizoniom2 said...

so then what is the method to deal with an insolvent financial institution of the size of the money center banks? are you saying the only choice is serial bailouts?

mattw said...

I do not think this argument holds true if you let the company go bankrupt first, which is what you need to do before you nationalize it anyway.

The correct question is whether letting the firms go bankrupt would be too horrible to allow. Personally, I think not allowing them to go bankrupt is too horrible to contemplate, but it seems to be contemplated. After bankruptcy, support. Not before.

Then let the lawyers fight if they want.

shunted said...

Thanks for the info.

Is nationalization different than what happened to IndyMac? I thought that when people talked about nationalization what they really meant was what happened to IndyMac.

Don said...

I need to find out more about this. Consider the following:
1) Banamex, Monex. Nikko Cordial, etc., run themselves, as far as I know.
2) Citi's plan is to sell most of these assets going forward anyway. They're simply waiting for a better market to unload them. They certainly want to keep Banamex, which could be sold.
3) Notice what Mexico did. From Inca Kola:

"And so Citigroup can likely keep Banamex, according to Mexican gov't politicos that have just earned themselves a "one large favour owed to me" card (and will surely know how to use it). Reuters translates the moneyline which is being used....

"The law does not cover emergencies derived from the global crisis"

.....which is, of course, a total affront to logic and commonsense. Y'see according to Mexican lawmakers the clear legal statute that does not allow any foreign government to hold more than 10% of a bank doing trade in Mexico suddenly doesn't count because......because....because the US gov't didn't WANT to buy 36% of Citigroup ....and that makes it different. Cos they said so. And that national laws go out the window and Mexican pants are dropped to US pressures isn't really news. After all, it's greedy human beings we're dealing with here so logic obviously has to take a back seat. I'll just shrug my shoulders and scrunch my brow a bit and go "waddya expect?".

Bloomberg does a good job of explaining the outcome of the Mexican mental and legal gymnastics that lawmakers have gone through to get to this point. Here's the link worth reading. The only thing lacking from both Reuters and Bloomie's reports are meaningful opposition quotes and positions."

I'm sure that it could be a hornet's nest in Mexican politics, but they moved pretty fast to change that law which we were already violating.

In other words, I don't see why am FDIC type organization can't do what Citi is trying to do. After all, they might do a better job.

Don the libertarian Democart

Christopher Wheeler said...

I don't think the compensation issue is that much of a deal killer. At today's stock price, Citi is worth about $16 billion.

Why not treat it as a hostile takeover? Heck, it doesn't even have to be hostile. Just prior to bankruptcy, the Citi BoD would happily agree to sell themselves to the government.

There are a lot of good reasons not to nationalize the banks, but I don't see compensation for the stockholders as being a holdup.

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