Wednesday, April 14, 2010

My bit part in the Krugman-Sorkin debate

There is – at the New York Times – a spat between Paul Krugman and Ross Sorkin over whether Krugman was ever in favor of wholesale bank nationalization. 

I had a bit part in this debate – so I think I can offer some perspective.  Krugman debated the issue with me in his blog:

Who to nationalize (somewhat wonkish)

John Hempton somewhat misunderstands my point, but that’s OK. I should have been clearer — and he and I actually seem to be mainly in agreement.

I was not saying “nationalize all the banks”; I was saying do what the Swedes did — in tandem with a guarantee on bank liabilities, take the banks with zero or negative capital into receivership. It’s really important that you do this: if you offer a blanket guarantee on the assets of a bank that’s already underwater, you (a) are very likely to take a large hit on taxpayers’ money, without any share in the upside (b) create a huge moral hazard/looting incentive.

Basically, you really don’t want to turn Citigroup into a $2 trillion version of Lincoln Savings and Loan. If you guarantee the liabilities of a stronger bank, by contrast, it’s probably OK even if you don’t take it into receivership.

Let me also say that I think a blanket guarantee without some kind of seizures will just fuel a vast — and justified — populist rage.

Anyway, I think Hempton and I are more or less saying the same thing: guarantee all bank liabilities except for [fill in the blank here], while taking over large banks that are essentially insolvent.

I remember this well.  I thought it perfectly reasonable to nationalize large banks – but only after due process.   I thought that the Government should issue a “guarantee” over all big financial institutions – especially if they could get away with an implicit guarantee (as per the statement “no more Lehmans”).  And then they should have a process for determining which banks they would confiscate.  The process should determine how much additional capital that the bank would be required to raise.  If they did not raise it then they should nationalize it.  The idea was to nationalize in a way that respected the property of private equity providers.  [Incidentally the stress tests and the compulsory capital raises worked out roughly this way…]

I thought that nationalization without due process would be a disaster.  I worried at the time that Paul Krugman was in favor of some things that did not look like due process.

And indeed he was.  He was explicitly in favor of nationalizing Citigroup and Bank of America.  I thought he had no process for arriving at those two and wished to call him on that.  I happened to agree with him on Citigroup – but I disagreed with him on Bank of America and was busy buying shares.  When we started taking money for clients (June 2009) Bank of America was our largest starting position.  [Incidentally I thought that Barclays would probably wind up as Government property – and I seem to have been wrong on that.  We all got things wrong.]

Krugman was wrong about BofA.  Nationalization of it without a process (as per the confiscation of WaMu) would have been a disaster – a death-blow for confidence in the system.  It would – in my view – have led to the nationalization of the whole system – something that Krugman never advocated.

Krugman did want to nationalize banks that were ex-post sovlent (BofA in particular).  I think he wanted a process for doing it (witness his comment about negative net worth) – but he never spelt out the process.  Moreover he was polemical on nationalization and weak on process more generally. 

Sorkin is flat wrong when he says that Krugman wanted to nationalize the banking system.  I call it that way as do most other commentators.  But Krugman’s position is hard to defend because he was in favor of some nationalization, some of the nationalization he was in favor of (particularly BofA) looks flat-out-dumb and he never spelt out a process to get it right.


Anonymous said...

From an admittedly biased source, why were you not both wrong on Citigroup? The government is marked up about $16B on its Citigroup capital injection and is expected to be fully out of its investment by the end of the year.

Anonymous said...

I wouldn't have thought it's really even now possible to say who is 'ex-post solvent'. Given the banks are sitting on a mountain of loans that, if they truly had to mark them to market, might only be worth a fraction of their par value they are currently marked at, it's entirely possible that a large part of the banking system is still insolvent.

John Hempton said...

Several answers:

1). Citigroup did have a due process - the private sector WAS given the opportunity to put up capital - and they declined that benefit.

That happened to some extent in Sweden too - where banks wound up partly government owned but were solvent... the private sector did not pony up.

2). Second response. Citigroup simply needed MUCH more capital than anyone else to be there. The government might be up - but the government owns it anyway. I think Citi WAS nationalised - temporary and the process was due process.

3). Citi was multinational and that meant that it needed a bailout of its foreign deposits - and they had desperately insolvent foreign operations everywhere... but that is hard to model.


Unsympathetic said...

Anon@10:22 last night.. what are you talking about? ALL the TBTF banks are insolvent - today, right now, with no changes.

All TBTF banks keep their HELOC loans on the BS at par (or 95c, close enough.) They're all worth zero, and the losses need to be taken (and bonuses clawed back that were handed out based on origination volume) before any positive growth can occur.

John, I for one don't care who was "right" about the nationalization.. but the write-downs need to happen before any growth can occur!

Anonymous said...

Hi John. Not related to this story but as it is the latest....

You contacted ASIC about Astarra Strategic Fund. Good job. How about MTAA Super Fund? Look at the Target Return Fund and how much of it is in the default balanced fund. then look at the digdy returns and the slow right off over the past 2 years. MTAA went from boasting about being number one fund to worst fund. members would not know. The fund is alos likely illiquid. Will APRA harass an industry Fund? Will You?

Aramf said...

I'm glad you made money on your BAC but I think it's important to remember two things:

1. In response to the crisis FASB suspended mark to market so how could an investor legitimately value the book of any of these companies given the proven lack of accuracy in their previous mark-to-model marks?

2. The U.S. government paid roughly 100K per house (if you believe CR's arithmetic to stabilize house prices therefore unless an investor predicted this would occur their valuation of the mortgage & HELOC books TBTF banks was wildly over-valued as it's clear IMO that housing prices would be much lower without the assorted federal subsidies put in place in response to the crisis.

Anonymous said...

Regardless of where this argument Krugman/Sorkin started, Sorkin's response and clarifications to Hoyt at NYT demand he be called out for egregious BS: "In Sweden’s case, he said, the government took over some banks but guaranteed the debts of all of them. “That’s how many people would define ‘nationalizing the entire banking system,’” he said."

Sorry, no-one would define taking over some banks and guaranteeing the debt of all them as nationalizing the entire banking system. (If you do define it that way, arguably the system was nationalized after Lehmann).

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