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Back-Door Nationalization?, Part 2


Government makes uncertainty and fear the new normal for the US banking system.

Editor's Note: James Kostohryz was formerly the head of international investments for a major Brazilian investment bank.

This is part 2 of a 2-part article. Part 1 can be found here.

Make no mistake: It's clear from the SCAP report released on Friday that we're potentially facing a backdoor nationalization of the banking system. And with this, we'll have to deal with all the attendant inefficiencies. You want to see what happens when the government gets involved in running banks? Take a look at Fannie Mae (FNM) and Freddie Mac (FRE).

Or take a look at the public-sector banks in Europe and Latin America: Each is a manual for creating economic-growth destroyers and fiscal black holes that can severely distort entire economies, cripple overall economic competitiveness, and even bankrupt entire nations.

As I wrote in Bernanke to Banks: I've Got Your Back, Bernanke could have kept this from happening. The SCAP paper presages a future afflicted by the following uncertainties:

1. Massive uncertainty for financial markets and the economy as a whole regarding future dilution and increased government ownership of private banks.

2. The government has set a potential trap for itself and the entire banking system by formalizing an unprecedented and rigid capital adequacy standard centered primarily on TCE - as well as a CAP regime that, due to the rigidity of the TCE standard, may soon prove to be inadequately funded if the economy deteriorates beyond the current worst-case scenario.

3. Over the next few months and years, the financial markets and the US economy will be plagued by massive speculation about the accuracy of the "worst-case scenario" and about banks' real need for capital. Since the government may soon run out of the original TARP money, this will in turn lead to endless speculation about the willingness of Congress to continue to "invest" in the banks under the CAP regime.

4. Institutionalized moral hazard for bond holders and unsecured creditors. Creditors are getting a completely undeserved "free ride" under the current regime. This isn't consistent with sound economic principles, or with principles of fairness, which is sure to bring about economic and political problems in the future.

5. Tremendous loss of competitiveness of the US banking system vis a vis systems not saddled with TCE requirements, "stress tests," compensation restrictions, or government ownership. For example, it's a virtual certainty that European banks won't impose a TCE standard like the US's. In fact, European banks have always been vastly less capitalized than US banks on this standard, having TCE ratios that are roughly half the US average, and this has never bothered European regulators. And the Japanese have been dealing with banks with negative TCE for decades, so they're even less unlikely to impose such tough TCE standards.

Similarly, European Japanese, Chinese and other banks could well take advantage of the disarray in the US banking system to "poach" key personnel (US banks will have compensation constraints), gain market share, and/or acquire US banking assets at fire-sale prices.

The tragedy is that these uncertainties could all have been avoided, or at least greatly mitigated.
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