Posted by: Nicholas Davis | March 10, 2009

Another impractical plan for solving the global financial crisis

Following from my last post about solving the global financial crisis and a previous one about bank nationalization, I’ve just come up with a completely unrealistic way of fixing the global banking system:

1) Freeze trading in all bank stocks worldwide, then “nationalize” the entire global banking sector overnight (to prevent a run on bank shares and be fair to everyone) – institute “type 4″ FDIC-style conservatorship where a range of agencies pledge to restructure banks along common guidelines, pulling out the nasty assets and getting the fairest deal for shareholders, bondholders and taxpayers in the process, thereby restoring confidence. Governments will probably have to guarantee deposits up to quite a high amount at this stage, globally coordinated so as not to have risk arbitrage occur. No withdrawals above this deposit limit. The G20 sherpas will be exhausted.

2) We employ an army of morally impeccable (I know) auditors to go through all the world’s banking institutions in super-fast time, assessing value and cleverly netting off any nasty liabilities or assets here between banks and hence hopefully off-setting some loans and reducing leverage that way. The auditors could make a report on the viability each bank using stress tests that constitute optimistic (WSJ) and realistic (Roubini) forecasts. Daily calls between the head auditors of the biggest 20 banks in the world would be needed to coordinate work. Given that all banks are being restructured at once, and all deposit guarantees are the same, people might realize this is just a clean-out of the system and everything will be rebooted to a clean state. All information as it arises is posted on a comprehensive website for everyone to see and track (remember the guarantees and limits!).

3) When the initial analysis is complete, there is a second round of coordination efforts to decide how best to consolidate both toxic assets and real assets (in the form of infrastructure etc) around the world, to restructure all institutions into the healthiest possible entities. Then, agencies pay out the bondholders in failed institutions as best they can – in some cases perhaps by converting their old debt into new preferred or common convertible equity in entities which will hold the secure assets and operations etc. On re-privatization, the bondholders could exit, and new debt could be raised if required. (I’m wobbly on this point – taxpayers may have to pay-off some bondholders here…)

4) “Bad” assets will be held collectively in a separate set of funds, owned by relevant taxpayers so they get the upside, should they be worth anything. At some stage, these “bad banks” might be IPO’d too, to pay out taxpayers.

5) We replace the managers of failed and almost-failed banks with new ones and make them do trust exercises with their subordinates, celebrate moral heroes in banking, and create board-level “head of risk and uncertainty” positions (who immediately initiate a range of scenario planning projects on the future of their banks and ban VaR models from the intranet) etc etc.

6) Meanwhile, while the banking sector is functioning but in stasis on stock markets, we fast-track new financial regulations. This might include new leverage limits, counter-cyclical reserve requirements and “smart transparancy” – i.e., information flows about potential problems that can detect destructive feedback loops on markets and starts introducing taxes on trades that look speculative or dangerous in terms of contagion. We also agree on macro-prudential rules etc etc. In the spirit of global coordination, and to prevent the kind of financial fragmentation William Buiter points to we might even consider need a global lender of last resort or something (gasp! sovereignty!).

7) The following morning, with only CR understanding much of what’s going on, markets reopen with many of the old banking stocks delisted, and a few survivors with a clean bill of health. Over the next few weeks, new banking stocks are listed on various exchanges, with many entities already owning stock in by default thanks to the restructuring. With the bad assets gone, values should rise to represent future potential output in the expected economic conditions, and lending should resume among more or less normal lines (although subject to the new regulation).

8) Heaving a sigh of relief, we suddenly realise that one of the most pernicious aspects of the global financial crisis is over, and rush to the bank to get a home loan, only to find that Warren Buffett already owns the sweetest deals.

Pros:
-Complete clean out of all banks at the same time, everywhere
-Global coordination is built in and assets and liabilities can be consolidated across borders
-Regulatory uncertainty is removed from financial markets as the market for bank stocks is shut while regulation being prepared
-Prevents arbitrage between banks, lowers incentives for a run on deposits and removes prospect of a run on bank stocks
-May turn up more fragile institutions sooner rather than later
-Creates lots of jobs for auditors and accountants
-others??

Cons:
-It is completely impossible to execute because of:
–political objection to cost and ideology of wholesale nationalization
–national interests and time required to coordinate
–scale of auditing and conservatorship required, lack of talent
–differing capacities in different countries/states
-Could cause severe damage to financial markets unless this can literally be done overnight
-would threaten national sovereignty for many countries
-there are a number of massive mistakes in the analysis above
-others??

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Responses

  1. […] or categories have I missed from this list? Third, how can we improve these elements in the newly constituted global financial […]

  2. You had me at “freeze trading in all bank stocks worldwide.” Haha.


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