The Swedish Solution

Nouriel Roubini and fellow NYU professor Matthew Richardson take to the WaPo to push for Plan N. The details:

Nationalization -- call it "receivership" if that sounds more palatable -- won't be easy, but here is a set of principles for the government to go by:

First -- and this is by far the toughest step -- determine which banks are insolvent. Geithner's stress test would be helpful here. The government should start with the big banks that have outside debt, and it should determine which are solvent and which aren't in one fell swoop, to avoid panic. Otherwise, bringing down one big bank will start an immediate run on the equity and long-term debt of the others. It will be a rough ride, but the regulators must stay strong.

Second, immediately nationalize insolvent institutions. The equity holders will be wiped out, and long-term debt holders will have claims only after the depositors and other short-term creditors are paid off.

Third, once an institution is taken over, separate its assets into good ones and bad ones. The bad assets would be valued at current (albeit depressed) values. Again, as in Geithner's plan, private capital could purchase a fraction of those bad assets. As for the good assets, they would go private again, either through an IPO or a sale to a strategic buyer.

The proceeds from both these bad and good assets would first go to depositors and then to debt-holders, with some possible sharing with the government to cover administrative costs. If the depositors are paid off in full, then the government actually breaks even.

Fourth, merge all the remaining bad assets into one enterprise. The assets could be held to maturity or eventually sold off with the gains and risks accruing to the taxpayers.

The eventual outcome would be a healthy financial system with many new banks capitalized by good assets. Insolvent, too-big-to-fail banks would be broken up into smaller pieces less likely to threaten the whole financial system. Regulatory reforms would also be instituted to reduce the chances of costly future crises.

The more I see about Plan N, the more I believe Geithner and Obama will have no choice but to go this route. Yes, it includes the dreaded "bad bank" there as step 4, but remember, the main problem of "bad bank" is the quandary that there's no price that can be paid for these toxic assets that both keeps the insolvent banks afloat and isn't a complete waste of taxpayer money. If you nationalize the insolvent banks beforehand, the moral hazard of the first half of the unsolvable "bad bank" equation vanishes, and you only then have to worry about getting the taxpayers a good deal, which is much easier.

Of course, "good deal" in this case is relative. They're still crap and will remain crap for a long time.

Still, this is the clearest argument yet for Plan N, how it would be executed, and why it should be so (read the whole thing).

Ironically the main argument I'm seeing against Plan N is not the argument you'd expect. People are yelling that nationalization is evil, that it's fundamentally against the free market and all that. That argument is dead and buried after the multiple wave of taxpayer bailouts are now the only thing keeping these zombie banks going. They are already effectively nationalized and would be gone without the bailout billions, period. There's no argument against that.

Rather, again, it's the political argument, as I've said. Obama can't nationalize the banks because of the political backlash. But eventually, the political backlash of the failure of the economic system in this country will exceed that of Plan N, and when that happens, he has no choice.

The argument then becomes when he'll do it.