I'm sorry, Simon Johnson's argument that the government should seize the worst banks (e.g., Citi, BofA), force a debt-for-equity swap over the weekend, and re-open them as well-capitalized entities on Monday, is really detached from reality. This is, in effect, the "temporary nationalization," or "managed receivership" argument that has become so popular among commentators. (Since everyone knows that Citi would be the first bank to be nationalized or taken into receivership if the government went that route, I'll focus my discussion on Citi.) Let me try this again: Nationalization of a bank like Citigroup is not possible. Receivership is also not possible, even if Treasury's proposed resolution authority for major financial institutions passes. Citigroup is an international financial institution. It has branches and subsidiaries in over 100 countries. As Justin Fox points out, of Citi's $755 billion in deposits, $515 billion are outside the US. In general, each of Citi's foreign offices is subject to the insolvency laws of the country in which it is located. If the government put Citi in receivership or conservatorship, most of these foreign countries would seize the assets of the Citi subsidiaries in their jurisdictions and begin their own bankruptcy procedures. Any legitimate claims the US has on Citi's foreign assets would be governed by a convoluted web of international agreements. The complications don't end there. Citi has over 2,000 principal subsidiaries. The Treasury's proposed resolution authority—which is essentially a scaled-up FDIC resolution, with a few changes—doesn't apply to subsidiaries which are registered brokers or dealers, insurance companies, FDIC-insured depository institutions, hedge funds, investment advisors, or private equity funds. (I'm sure I'm missing some too, since I'm not a bankruptcy lawyer by any means) The insolvency of registered broker-dealer subsidiaries is handled primarily by the Securities Investor Protection Corporation (SIPC) under a resolution procedure designed specifically for broker-dealer liquidations. Insurance company insolvencies are governed by state insurance regulations, and handled by state insurance authorities. Obviously, the FDIC handles insured depository institutions under its traditional resolution authority. The rest of the subsidiaries not covered by the Treasury's resolution authority are thrown into bankruptcy court. And this is all before you get to the actual restructuring, which would almost have to take the form of an FDIC-managed conservatorship. The assets and liabilities that the FDIC ultimately takes into conservatorship would likely be badly mismatched on several levels, and would bear almost no resemblance to Citigroup's pre-insolvency assets and liabilities. Seeing as the only bank stupid enough to buy this kind of mangled, leftover balance sheet outright is .... umm, Citigroup .... the FDIC will have to do some serious restructuring. In all likelihood, that means bondholders will have to take haircuts. How did that work out with Lehman again? Oh, right. It caused an epic financial panic that almost brought down the global financial system. Good luck with that. Cheer up, though: you're almost a third of the way through the vaunted "temporary nationalization" process. I won't bore you any further. Suffice to say that this doesn't even scratch the surface of the legal obstacles to nationalization or receivership. As I'm sure you can see by now, the idea that Citigroup can be taken into receivership, restructured, and recast as a well-capitalized bank all in one weekend, is borderline delusional. The broader point is that no matter how well a Citigroup receivership works in a Paul Krugman or Simon Johnson hypothetical, in the real world it's not a serious option.

15 comments:

septizoniom2 said...

please then comment on what you see as the path of resolving an insolvent fin institution of the size or complexity of citigroup

Don said...

OK. Here's where there might be a misunderstanding about nationalization. If Citi continues to need government aid, we will eventually own the majority of the stock. At some point, it might be necessary for the US to take effective control of Citi. I guess that we could put in our own management, and unwind Citi ourselves. After all, that's what they admit that they have to do. At some point in this process, Citi will be much smaller. Again, they say themselves that they are going to be much smaller. We might then sell the shares, seize it, how do I know. But there has to be some kind of plan other than just giving them whatever money they need no matter how incompetent that they are. Remember: We already are shareholders.

Don the libertarian Democrat

Anonymous said...

"If the government put Citi in receivership or conservatorship, most of these foreign countries would seize the assets of the Citi subsidiaries in their jurisdictions and begin their own bankruptcy procedures."

Are you claiming that the bankruptcy of the holding company would necessarily lead to the bankruptcy of every subsidiary?

This view requires some explanation.

Economics of Contempt said...

septizoniom2,

Absent a Purchase & Assumption agreement where the government simply closes a failed bank and hands it to a waiting buyer (e.g., WaMu to JPMorgan), I honestly don't think it's possible to resolve an insolvent financial institution of Citi's size and complexity without causing unacceptable damage to the financial markets.

Financial markets move incredibly fast now, whereas liquidation and reorganization are both necessarily much slower processes, with a high level of uncertainty built-in. I wish there was an answer, but there just isn't.

Economics of Contempt said...

Don,

I don't think the choice is between indefinitely shoveling money to Citi with no-questions-asked, and outright nationalization. Citi is already in the process of downsizing and restructuring (e.g., Morgan Stanley Smith Barney), but that process takes time -- it's not instantaneous. It would take the same amount of time if Citi were nationalized. Yes, taxpayers are already shareholders, but what else would you have Pandit & Co. do?

Economics of Contempt said...

Are you claiming that the bankruptcy of the holding company would necessarily lead to the bankruptcy of every subsidiary?

This view requires some explanation.


I didn't mean to make that claim, but you're right that it reads that way. How the bankruptcy of the holding company would affect Citi's subsidiaries is, obviously, an exceedingly complex question that I'm in no position to answer.

But if the holding company filed for bankruptcy, I suspect that a substantial number of Citi's subsidiaries would be pulled into bankruptcy as well. The Fed still takes the "source of strength" doctrine seriously, which essentially requires the holding company to bankrupt itself helping its subsidiaries. So if the holding company filed for bankruptcy, all of the subsidiaries that the holding company spent its last days trying to save would presumably soon follow suit.

If that day ever comes, some lucky Weil Gotshal attorney will have the privilege of sorting all this out.

Don said...

"It would take the same amount of time if Citi were nationalized. Yes, taxpayers are already shareholders, but what else would you have Pandit & Co. do?"

What I'm saying is that, as shareholders, we need to assess Pandit and Co.s performance.For instance, we might disagree with their continuing to hold a particular asset. If Citi were to ask for more money, we would do the same. If we give them more money, and received stock in return, we might well, for all practical purposes, own Citi. Whether you call that nationalization is a good question. In any case, we might well have to put in our own team. That was my point: In a sense, it's a distinction without a difference. Whether we seized Citi or simply put in our own team, the game plan might well be the same.

So, I was suggesting that, even if we cannot do what you suggest, we might well have to do something very similar. Since we were already legally shareholders, I didn't see any legal problems to our becoming majority owners, and essentially owning the company.

At some point in that process, I was suggesting that we might be able to either sell our stock and get out, or, after pruning Citi down, seize it.

It would not be easy or immediate, but that's a good reason to push forward legislation that can alleviate this problem in the future. Since we seem to agree on so much, I was asking if you were thinking of our owning Citi, if it happened, as nationlization or not. I simply wasn't clear.

Don the libertarian Democrat

mattw said...

You have a different definition of "not possible" than I have. Your definition seems closer to "disruptive", "unpleasant", or "unpredictable".

I don't really see how that would be worse than the current situation.

Anonymous said...

Citigroup may not necessarily be nationalizable, but Citibank must be because it's FDIC insured. Whether "nationalizing" Citibank (as opposed to Citigroup) would solve the larger problem is a good question, but clearly if an FDIC-backed institution is not possible to be put into receivership then it shouldn't be FDIC insured!

Anonymous said...

The bottom line then seems to be that highway robberty of taxpayers by financial institutions is unavoidable. Shall you tell them or shall I?

Anonymous said...

Regarding this post and the previous too big to fail (TBTF) post, does antitrust legislation have any bearing in this situation? Is a TBTF institution equivalent to a monopoly? Since the TBTF institution cannot be allowed to fail by society, it will enjoy a competitive advantage similar to that of a monopoly. There have already been reports by that AIG was undercutting insurance competitors' prices courtesy of the bailout. Can these TBTF institutions be broken up via antitrust actions?

rsgoldfeng said...

Citigroup might notD3 Items exactly actually possibly be nationalizable, although Citibank need to be because it is FDIC covered by insurance. No matter whether "nationalizing" Citibank (rather than Citigroup) could fix the more expensive problem is an excellent issue, yet plainly appears to be FDIC-backed organization is not possibleRS Gold to be placed in receivership then it mustn't be FDIC covered!

dte said...

c9 moneyexperience is a hard teacher because she gives the test first, the lesson afterwards, c9 gold the consequences of today are determined by the actions of the past. To change your future, alter your decisions today c9 online gold.

dte said...

When you're down, and the world seems dark and empty, your forever friend lifts you up in spirits and makes that dark and empty world suddenly seem bright and full Diablo iii Gold Sale, this is Forever Friendship Diablo III Gold, someone who convinces you that there really is an unlocked door just waiting for you to open it Diablo 3 Gold.

mengmeng pan said...

Have a lovely time with your beloved cousin. Please keep posting Pigeon. She is so much part of your blog.Billiges Smartphone ohne Vertrag online kaufen I hope all good things happen on your trip.