Roubini And Plan N

Nouriel Roubini lays out the most coherent and intelligent argument yet that Obama will have no choice but to nationalize insolvent banks before the end of the year. The most interesting passage is why Roubini believes Obama hasn't made the move to do so yet: (emphasis moi)

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.

And that's the bottom line: Obama can't nationalize now or the panic will wipe out the financial system. However, by delaying nationalization now, he is effectively assuring that major national banks and almost all the regional banks will be taken over before the end of the year, or by early 2010 at the latest.

I call that one the "Deep Impact" quandry. In that movie where an asteroid is hurtling towards the Earth, the President, played by Morgan Freeman, can't tell the world that a rogue asteroid is going to destroy much of the life on Earth, but if he does, the economic and political impact of the resulting panic will result directly in death...and there's always a chance the NASA guys could be off by enough that the asteroid could do less damage than expected.

Obama's facing a similar situation with our banking system. It's going to get wiped out within a year most likely, but admitting that it's going to happen means the banking system will be wiped out now instead.

Obama's going for the current plan on the .01% chance it'll work, because Plan N involves admitting a massive problem and then trying to fix it in the middle of a huge financial panic. We're insolvent, but people aren't aware of it yet. Obama pulls the trigger on Plan N, and everyone will know.

Bank runs? Stock crashes? Looting? Who knows? 300 million people, some of them are likely to start doing something stupid.

So, when does Plan N become politically viable? That's the quadrillion-dollar question.

New tag to follow the path of world bank nationalization: Plan N.