One (possible) reason Geithner's not nationalizing...yet

Some advocates of bank nationalization make it sound quick and easy -- get in, clean up, get out. As for wiped out shareholders and damaged bondholders - tant pis, taxpayers come first.

FinanciaWeek's editor Ron Fink today offers a credible glimpse at one major complicating factor. Certain bondholders may command a strong measure of consideration:

Although it is impossible to prove their contention based on publicly available data, [some] analysts suspect that China’s holdings of the debt of banks such as Citigroup and Bank of America are one reason the Obama Administration is hesitating to take over those banks and restructure them with taxpayer assistance.

Although an increasing number of experts contend temporary nationalization followed by a spin-off of the banks’ good assets to private investors would be the most effective way to resolve their financial woes, that would wipe out the value of current shareholders’ holdings. What’s more, nationalization would force bondholders to take a substantial hit.

The U.S. government, these analysts say, is simply unwilling to subject Chinese financial institutions to such losses, particularly at a time when Uncle Sam needs these overseas lenders to finance America’s growing deficits through Treasury bond purchases. While China needs these purchases to hedge its exposure to the dollar as a result of its reliance on exports, Beijing has been shifting its capital investment priorities from exports to domestic infrastructure—not surprising given U.S. imports have fallen during the recession.

The Chinese continue to buy U.S. debt, Fink notes, in large part because it's in their interest to support the dollar and so maintain the value of their export income. At the same time, Beijing is "shifting its capital investment priorities from exports to domestic infrastructure." A loss of what could be in excess of $150 billion on U.S. bank debt, triggered by nationalization, might prompt a more sudden Chinese turn away from Treasury bond purchases.

Nouriel Roubini, one advocate of nationalization who doesn't mince the difficulties, has suggested that the time won't be ripe for another six-odd months, when it's clear which banks are insolvent and nationalization of the largest insolvent banks can be done "at one fell swoop." The China hypothesis suggests another powerful motive to make haste slowly on this front:

[Brad] Setser noted that.... he wouldn’t be surprised if China were trying to reduce its exposure to the debt of Citi and B of A. “Post Lehman, post [Fannie and Freddie], it seems like China is shifting back into Treasuries quite quickly,” he wrote.

So if the scenario that played out at Fannie and Freddie scenario is any indication, the Obama administration may be waiting for China to reduce its exposure to the debt of the latest U.S. financial institutions found lying near death’s door before it nationalizes them.

Geithner may have got off on the wrong foot but he's no fool. It's neither ideology nor timidity that's holding back a bank cleanup. It's likely a matter of timing, damage control, first doing no harm, and minimizing unintended consequences. Drugs and exercise before radical surgery.