Friday, 24 April 2009

Why the US prefers quasi-nationalization for banks

Steve Waldman writes an excellent blog called Interfluidity on financial matters and has a very good post concerning the pressure that was put on Ken Lewis by Henry Paulson and Ben Bernanke to complete the acquisition of Merrill Lynch.

The allegations which have been documented, and are available all over the web, are that Lewis was threatened by Paulson and Bernanke that if he failed to complete on the acquisition of Merrill at the end of last year then he (Lewis) and his board (i.e. the Board of B of A) would have been dismissed.

This is a very troubling allegation and as Waldman points out what makes it most egregious is the complete lack of accountability that was enjoyed by Paulson especially during the last quarter of 2008.

An assertive Treasury secretary has tremendous leverage over zombie bank managers. Instead, what we have is control without accountability. An informal, unauditable, hydra-headed set of private managers and public officials controls how quasinationalized banks behave. Neither taxpayers nor shareholders have reason to believe that decisions are being taken in their interest. The informality and disunity of control impedes the kind of hands-on, detail-oriented supervision and risk management that ought to be the core preoccupation of bank managers.
Waldman is right to insist that the issue highlights the absurdity of the "twilight" zone in which many major banks in the US currently occupy. They have neither been nationalized or taken through receivership by the FDIC ,nor have their current management been fully held to account for their stupendous mismanagement.

Why has the US government tolerated this Twilight Zone existence for Citigroup, B of A and others?

There are several reasons why "quasi-nationalization" has been chosen as the preferred route and the fact that Administration officials can intimidate current management, as evidenced by the revelations now appearing with regard to Bank of America, without having to take on full control and responsibility is certainly one of them.

Another is that it avoids having to deal with the debt-holders and the third is that it prevents triggering lots of CDS contracts.

Seen in this light it is not surprising that the government is doing all it can to avoid putting those troubled banks into receivership. Only in the fullness of time will the error of this approach be confirmed.

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