Nationalization is a taboo word for investors and policy officials alike. Loosely defined as a government body taking control of a private firm and its assets, this act directly contrasts the capitalist and free-market economic ideas that have proliferated around the world.
Needless to say, when investors learn that their stake in an equity or debt holding has been rendered worthless, confidence in that economy and its investment opportunities is severely deflated. History has shown that the world’s largest capitalist economies rarely fall back on such options; but over the past year, unprecedented financial shocks and a global recession have called for desperate measures. Recently, some of the world’s largest economies have started to move into indiscernible shades of nationalizing gray as governments place regulations on loaned funds to, buy shares in and even some cases take control of key financial institutions. For its own part, the US has taken aggressive steps towards taking a significant or full-ownership stake in major banks and lenders. How far will the US government go and how will it affect a dollar that is considered one of the top safe havens?
[B]Nationalization – What Have the Euro-zone and UK Done?[/B]
Over the past 18 months, a US-borne economic and market crunch has developed into a global one. And, with credit all but vanishing and major financial players teetered on the edge of failure, governments were prompted into action. Initially, the efforts made by officials were through interest rate cuts and expansion of money market operations by central banks. However, with time, conditions deteriorated and measures were expanded to include direct bailouts and guarantees on liabilities. At this point, the specter of nationalization started to take shape. However, before speculation of full-blown government takeovers started to circulate in the US, some of the country’s largest trade partners were already crossing the line.
In Europe, there were two remarkable cases of the government taking a clear role in salvaging failing private institutions with government funds. The first example was the joint Belgium, Luxemburg and Holland purchase of Fortis on September 29th, 2008. Once the 20th largest company in the world by revenues, the company was bought out and pieced off with public funds facilitating the immediate bailout. With painful exposure to the mortgage-backed securities market, Hypo Verizon similarly found itself in dire need of a government bailout. After two injections the bank was kept afloat by €52 billion in public funds. In response to these two very public interventions, the euro’s steady advance was weighted and eventually turned with help from rate cuts and data that put the Euro Zone economy into a recession.
The UK’s intervention has amplified a stark recession to pull the British pound to lows not seen in many years. The quick collapse in Northern Rock was perhaps the first major nationalization of a private company since the crisis began. Once one of the top five mortgage lenders in the United Kingdom, a customer run on Northern Rock exacerbated liquidity troubles and eventually forced the company into state ownership to avoid its failure on February 17th, 2008. The next notable acquisition didn’t occur until September 29th when a failed rights issue left Bradford & Bingley in the hands of the government, which sold off its deposits and held the mortgage book on its own ledger. Since then, a number of banks have required massive injections of liquidity and confidence in market stability was severely shaken. Once representing the financial capital of the world (London) the sterling has since been driven to record lows against the euro and Japanese yen as investors seek safety of funds.
[B]The US Takes Steps Towards Nationalization[/B]
Though nationalization is a fear that has really gained traction only over the past few weeks in the United States, actions by the government have steadily laid the ground work for such a move. Like most of the other largest economies, the US first steps were sharp interest rate cuts and offering billions in capital through short-term lending auctions. This would not stabilize the credit markets and make a dent in the ballooning recession however; so the US upped the ante. A $750 billion Financial Relief Program, $787 billion fiscal stimulus bill, $1 trillion in funds earmarked for making consumer and business loans and a proposed joint public/private investment fund aimed at buying up toxic debt were steps aimed at restoring stability to the markets and turning the economy around. These were the sweeping efforts of a new administration that was looking to snuff out the economy malaise once and for all. More importantly for investors though, there have been previous and more recent measures that seem very much like nationalization.
What many investors believe started the global financial crisis in earnest was also a government brokered deal that was one step away from an outright takeover. Bear Stearns, one of the largest players in mortgage backed securities, suffered losses and massive client withdrawals that eventually put the company on the chopping block. The US government barely avoided having to take control of the firm by striking a deal for JP Morgan Chase to buy the company for a severely depressed $10 per share (initially $2 per share) on March 24th, 2008. As the crisis continued and the stakes mounted, the government was forced to grow more brazen. On September 6th of the same year, the US put Freddie Mac and Fannie Mae under conservatorship of the Federal Housing Finance Agency. This escaped being defined as a true nationalization as the firms were already government sponsored enterprises (GSE). Intervening in insurance-giant AIG’s collapse took the US one step closer. After the failure of investment bank Lehman Brothers, investors shifted their focus to the similar balance sheet of AIG. An eventual $150 billion loan was made to the firm in exchange for warrants worth 79.9 percent of the firm’s equity.
With the market’s still veiled in uncertainty and fear, the most recent policy outlines by Treasury Secretary Timothy Geithner, Fed Chairman Ben Bernanke and President Barack Obama move the US to the possibility of nationalizing key players in the nation’s banking industry. Concerns that the economic slump could last longer than many banks are prepared for has led officials to conduct ‘stress tests’ of the 19 largest US banks. The architects of this plan have suggested the review was purely to find those financial participants that would not survive an extended recession so that they can be infused with additional government funds to weather what may come. However, this capital is expected to come at the price of preferred shares that are convertible to common equity that would give the US government a clear stake in the firm. What’s more, the plan left open the possibility for retroactively accepting shares from those that have borrowed in previous iterations of the ongoing bailout. This gives the US a right to ownership for a significant portion of the economy’s financial sector. While Fed Chairman Bernanke has been quick to say that the government has no intention of fully nationalizing any banks, many remain skeptical.
[B]Sweden - Why Their Nationalization Effort Was a Success, and Why It Won’t Work in the US[/B]
In a paper published by the Federal Reserve Bank of Cleveland titled On the Resolution of Financial Crises: The Swedish Experience, O. Emre Ergungor explains how a series of missteps in economic and monetary policy in Sweden during the 1980’s led to a massive credit boom which popped following the German unification in 1990. This was because Germany’s real interest rates jumped and since the Swedish krona was pegged to a basket of currencies, but primarily to the German mark, rates in Sweden surged as well and subsequently triggered a credit crunch that brought three of the country’s biggest banks to their knees. The first to fall were Första Sparbanken and Nordbanken in 1991, and once they announced that they could not meet the regulatory capital requirements, the government guaranteed all of their existing liabilities, took full ownership of Nordbanken, and helped Första Sparbanken with a loan guarantee to the owners. Within a year, Gota Bank found itself in the same situation and when its largest owner refused to provide additional funds, the state guaranteed all its liabilities to prevent a meltdown. Nevertheless, Gota declared bankruptcy the same month and Sweden took ownership of the bank.
From there, the government divided the banks’ assets into two separate entities to become “good” banks and “bad” banks. The “good” banks operated under their original names and were eventually merged into Nordbanken. Meanwhile, the “bad” bank assets were moved to two asset management companies (AMCs), with Nordbanken’s assets becoming known as Securum while Gota’s became known as Retrieva. In the end, the crisis was resolved quicker than expected due, in large part, to the global economic boom of the 1990’s which helped propel Swedish growth as well. According to the Cleveland Fed’s paper, there were other reasons why Sweden’s efforts were successful:
- The process was transparent and losses were revealed immediately in order to gain the market’s confidence.
- The process was independent in nature in order to shield decision makers from “political pressures” in what ultimately was an ugly process, as the decision to close a bank “must be economic-not a political-one.”
- Market discipline was maintained throughout the resolution process, because if everyone is bailed out, no one will fear the repercussions of excessive risk-taking.
- A plan to “jumpstart credit flows in the financial system by repairing the damaged creditworthiness of the real economy” was implemented right away. The paper explains, “Even if banks can be completely restored to health through recapitalization, borrowers may be in no position to repay any new loan they may get.”
Many have cited Sweden’s success as a reason to go the same route in the US. While some components could feasibly be implemented, such as the creation of separate entities by which to separate “good” and “bad” assets, there are also reasons why such a move wouldn’t work. First, many financial institutions haven’t revealed their full losses on toxic assets simply because there’s almost no way by which to value them. In order for the value of these assets to be calculated, pricing models must be created, agreed upon, and implemented. The news surely wouldn’t be pretty but the truth has to come out sooner or later.
Second, the likelihood of the process being fully “independent” has little chance of happening. American citizens are already up in arms about how much money has been thrown at the problems in the financial sector, and as a result, there are probably very few politicians that would put their job on the line to allow an entity to use whatever funds needed to sort out the mess.
Thirdly, the phrase “too big to fail” is rather common these days, especially since Fed Chairman Bernanke himself has said that there are financial institutions that fall into this category. As a result, the seeds of moral hazard - which were planted back when the government bailed out LTCM in 1998 - have simply flourished as the government has been quick to rescue anyone in the need of assistance, no matter who was to blame.
Finally, as we noted above, part of the reason why Sweden’s nationalization efforts were successful was because the global economy was still expanding at a quick pace. Now, though, most of the world’s biggest economies are either experiencing a major slowdown or are stuck in recession. Given the truly global nature of the credit crisis and the extent of the economic downturn, there is little hope that growth will start to pick up again until the second half of 2009, at the absolute earliest. Much of this recovery depends on the stabilization of the financial markets, but with various countries trying to piecemeal plans together, the outlook doesn’t look good.
[B]
Will the US Fully Nationalize? How Will It Impact the US Dollar and Risk Trends?[/B]
There are many arguments against the US having the ability to nationalize banks in a similar manner to that of Sweden, and based on what the US has done so far, they seem more likely to continue piecing together plans as time goes on. That said, it doesn’t mean that traders should completely write off the possibility. The “N” word has become very dangerous in the financial markets, with the mere utterance of the word by politicians apt to send risky assets plunging. As a result, if the US government were to officially announce such an effort, the stock markets would likely plummet lower as the news would only confirm the dismal status of US financial institutions. While brief bouts of optimism may be reflected in risky assets from time to time, they will likely continue to trend lower for many weeks or even months, as there is a general consensus amongst traders that the government is not very good at managing businesses, and that eventually, their efforts would only create new problems in the financial sector or at the very least, waste a significant amount of taxpayer money. For what it’s worth though, the US dollar has potential to maintain its safe-haven status relative to many of the major currencies, as the country has been perceived as being solvent and stable despite rocketing fiscal deficits and the nation’s dependence on foreign borrowing for financing. In the end, the implementation of nationalization could be highly bearish for the stock markets, but bullish for the greenback.</p>