Monday, March 02, 2009

The Taxpayer Will Pay

One of the undercurrents of the discussions of bank Nationalization is who should pay to clean up the banks' balance sheets.  I am of the view that regardless of how the bank cleanup is executed (whether it be a massive recapitalization a la TARP on roids, or a Swedish style bank nationalization) that the end result will be the same: the taxpayer will be on the hook for a couple trillion dollars.  In a nationalization you would see essentially what occurs in a bankruptcy.  The shareholder gets wiped out, the creditor takes a haircut and becomes the new owners or shareholders.   Seems clear enough, the taxpayer doesn't have to pay a dime.  

But I am skeptical of this proposition because the creditors are not some amorphous oligarchs.  Creditors come in the form of bond holders or owners of other fixed income instruments.  They are pension funds or the fixed income portion of 401(k)s.  If they take the hit instead of the taxpayer it will be retirees who are taking the hit.  After having just seen their stocks wiped out they will see their other revenue streams (annuities, bonds, etc.) reduced drastically.  You throw in people that are within a decade of retiring and you have a very powerful special interest.  These are people that vote and vote in large numbers.  Maybe they will be content to just live on their social security check, and take the hit.  But I am skeptical of this.  If you nationalize, I think there will be a massive movement to use social security as a vehicle to mitigate retirees and near retirees' losses. 

This is not an argument in favor of or against nationalization.  I think the taxpayer is going to be on the hook for a substantial sum of money irrespective of the method employed to fix the banking sector.  I think it's important to keep this in mind when we discuss fixing the banking sector.  There isn't a silver bullet that will protect the taxpayer.  For the purposes of planning a banking sector fix we need to assume that liability has already been booked and move on to other considerations.

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