Backdoor Nationalization? Maybe. But What's The Alternative?

by Noam Scheiber | April 21, 2009

I got into this a bit on CNBC last night (see below), but I figured I'd continue the debate off-camera, where I could have the final word.

The discussion centered around yesterday's New York Times piece reporting that Treasury may convert its stake in some of the major banks from preferred shares into common stock, which would basically free the banks from paying a 5 percent annual interest rate (via the preferred) in exchange for giving the government an explicit ownership stake (via the common).

Larry Kudlow and my two fellow guests argued that this was the culmination of Treasury's longstanding desire to nationalize the banks. The only real debate among them was whether Treasury was nationalizing through the back door or the front door.

My response was twofold. First, whatever you think about Geithner, it's safe to say his impulse is to avoid nationalization if possible. As I reported earlier this year:

Geithner and his colleagues are said to be deeply uncomfortable with the idea in principle. "Most people who run businesses in this area ... would look to nationalization as a last step--if it was the only thing standing between us and the abyss," says Michael Granoff, a private-equity fund manager who is friendly with several senior administration officials. "The people in charge of the economic policy side of things have pretty good communication with the people ... who sit where I sit," he says. "There is a shared understanding in these conversations."

This quote is hardly an outlier--I've had a number of well-positioned people tell me similar things.

Second, the relevant question isn't whether converting the preferred shares into common stock moves us closer to nationalization. It clearly does, if only very literally--in the sense that the government is gaining a more explicit ownership claim in the process. The question is closer relative to what. My sense is that Treasury is considering this step only in the case of banks that do poorly on the stress tests. Now, for such a bank, I can imagine three options other than the conversion that's on the table: One is to urge it to raise money from private investors, which seems extremely unlikely to happen. How attractive is a bank going to be when Treasury has effectively proclaimed it a stress-test flunkie (even if it doesn't quite put it that way). Option two is to inject more TARP money, which would presumably be in the form of equity, since Treasury apparently considers preferred shares to be debt and wouldn't want to increase the bank's debt burden. (And because additional injections of capital without giving taxpayers a share of the upside is probably tougher to justify politically these days.) Option three would be to seize the bank outright, FDIC-style.

So, of the three options other than conversion, the first is a non-starter and the second and third would mean an even bigger role for the government than conversion. If those are the relevant choices, it seems hard to interpret the conversion idea as a sign Treasury is bent on nationalization.

Having said all that, I admit there's something refreshing about debating Larry Kudlow on this stuff. He and I couldn't disagree more. But he's so upfront about his position--none of this mealy-mouthed hedging--that going at it with him turns out to be satisfying in a way it rarely is with people closer to me ideologically.


--Noam Scheiber

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