Mitch McConnell, bank-shrinker?

Ezra Klein has beat me to it again.  Today Mitch McConnell came out against Dodd's bank reform bill,  claiming that by setting up and funding a resolution authority that enables regulators to liquidate the largest financial institutions in an orderly fashion if they become insolvent, it is enabling and in fact guaranteeing future "bailouts." "“This bill not only allows for taxpayer-funded bailouts of Wall Street banks;  it institutionalizes them,” McConnell pronounced.

Klein points out that McDonnell is equating a liquidation that wipes out shareholders and management with a bailout -- and further notes that McDonnell is following to the letter a political strategy laid out by GOP pollster Frank Luntz in February: to equate any Democratic bank reform bill with the hated bailouts of 2008-09.

Cynical indeed. As Klein suggests, if you don't want to give regulators resolution authority over banks currently considered too big too fail, it would seem you would have to be in favor of not allowing banks to grow, or stay, too big to fail.   I would add that the only intellectually consistent, if insane, alternative to  breaking up, shrinking, or reining in today's behemoths or making provisions for their orderly liquidation is to take the position taken by many of the most ignorant and extremist Republicans in fall 2008: let 'em all fail and let the chips fall where they may. Pull down the whole temple of global finance around our ears.

But McConnell is not that crazy. He acknowledged last October that TARP “succeeded in stabilizing the banking system.” It seems fair to assume that he believes that the Federal government can't simply step back and let too-big-to-fail banks enter bankruptcy. That brings us back to Klein's question:  what steps would McConnell favor to make the behemoths smaller, or otherwise enable them to fail without systemic risk?

Roubini to Obama: "Make haste slowly" on bank nationalization

Many among the chorus of voices across the political spectrum now urging bank nationalization make it sound quick, clean and simple. The watchwords are "bite the bullet," "cut the Gordian knot"; the implication is usually that Obama and Geithner are wasting precious time and money and heightening market uncertainty by by dallying, trimming, refusing the grasp the nettle.

So it's striking that one of the highest profile advocates of nationalization, Nouriel Roubini, whose words today are freighted with the current gold standard of credibility, having forecast the market meltdown, argues yes, that selected behemoth banks must be nationalized -- but also that the time is not yet ripe. From today's Wall Street Journal:

So, will the highest level of government be receptive to the bank-nationalization idea? "I think it will," Mr. Roubini says, unhesitatingly. "People like Graham and Greenspan have already given their explicit blessing. This gives Obama cover." And how long will it be before the administration goes in formally for nationalization? "I think that we're going to see the policy adopted in the next few months . . . in six months or so."

That long? I ask. "Six months from now," he replies, "even firms that today look solvent are going to look insolvent. Most of the major banks -- almost all of them -- are going to look insolvent. In which case, if you take them all over all at once, you cause less damage than if you would if you took over a couple now, and created so much confusion and panic and nervousness.

While Geithner gets pounded for vagueness and Obama for timidity, look for Obama to follow the Emperor Augustus' watchword: festina lente. Make haste slowly. Wait till the bad bank harvest is ripe.

I'm not qualified to judge the wisdom or the direction of Geithner/Obama's long-term thinking about the banks. Or Roubini's, for that matter. I'm simply transliterating Roubini's implicit reading of what they're up to.

Here is the blueprint that Roubini and his colleague Matthew Richardson laid out in last Sunday's Washington Post:

Two important parts of Geithner's plan are "stress testing" banks by poring over their books to separate viable institutions from bankrupt ones and establishing an investment fund with private and public money to purchase bad assets. These are necessary steps toward a healthy financial sector.

But unfortunately, the plan won't solve our financial woes, because it assumes that the system is solvent. If implemented fairly for current taxpayers (i.e., no more freebies in the form of underpriced equity, preferred shares, loan guarantees or insurance on assets), it will just confirm how bad things really are.

Nationalization is the only option that would permit us to solve the problem of toxic assets in an orderly fashion and finally allow lending to resume. Of course, the economy would still stink, but the death spiral we are in would end.

Nationalization -- call it "receivership" if that sounds more palatable -- won't be easy, but here is a set of principles for the government to go by:

First -- and this is by far the toughest step -- determine which banks are insolvent. Geithner's stress test would be helpful here. The government should start with the big banks that have outside debt, and it should determine which are solvent and which aren't in one fell swoop, to avoid panic. Otherwise, bringing down one big bank will start an immediate run on the equity and long-term debt of the others. It will be a rough ride, but the regulators must stay strong.

Second, immediately nationalize insolvent institutions. The equity holders will be wiped out, and long-term debt holders will have claims only after the depositors and other short-term creditors are paid off.

Third, once an institution is taken over, separate its assets into good ones and bad ones. The bad assets would be valued at current (albeit depressed) values. Again, as in Geithner's plan, private capital could purchase a fraction of those bad assets. As for the good assets, they would go private again, either through an IPO or a sale to a strategic buyer.

The proceeds from both these bad and good assets would first go to depositors and then to debt-holders, with some possible sharing with the government to cover administrative costs. If the depositors are paid off in full, then the government actually breaks even.

Fourth, merge all the remaining bad assets into one enterprise. The assets could be held to maturity or eventually sold off with the gains and risks accruing to the taxpayers.

The eventual outcome would be a healthy financial system with many new banks capitalized by good assets. Insolvent, too-big-to-fail banks would be broken up into smaller pieces less likely to threaten the whole financial system. Regulatory reforms would also be instituted to reduce the chances of costly future crises (my emphasis).

Superficially, Roubini and Richardson seem to suggest that the Geithner plan is inadequate ("the plan won't solve our financial woes") and that nationalization is straightforward (4-step program). At the same time, they mark Geithner's stress test as a necessary first step, acknowledge the enormous difficulty and risk inherent in nationalization, and -- as in today's Journal interview -- stress the importance of timing in steering through the anticipated "rough ride." The key is to do it "in one fell swoop," and that can't be done yet.

Obama has built the reputation of a master of timing. Let's see how he rides the nationalization tiger.