Let’s assume that Citigroup really is in sufficiently bad shape that it cannot survive even after breaking up. Three rounds of government bailouts of the company are insufficient; the choices are either that the government buys up everything on Citi’s balance sheet that is at all problematic, or that the government seizes Citi itself – a true nationalization.
The problems with the former solution are well-known: the difficulty establishing a reasonable price for the assets in question; that fact that Citi shareholders benefit at the taxpayer’s expense; etc. The argument for nationalization is that it is clean and fair: equity investors are wiped out, the bank continues to operate, and the taxpayer gets all the upside (if any) once the assets are disposed of.
I don’t really disagree with that – if we look at Citi in a vacuum. But what if we look at it from the perspective of a Bank of America shareholder.
Once Citi is nationalized, its cost of borrowing plummets. To the extent that it continues to operate (and enabling it to continue to operate is the whole point of nationalizing it), it now has a competitive advantage over non-nationalized banks. Moreover, the assumption is that it will be re-privatized in short order minus its problematic assets – a neat trick that competing banks can’t pull off. That gives them a further competitive advantage. Finally, equity shareholders in other banks will have the precedent of the Citi nationalization staring them in the face as they contemplate their own investment. How sure are they that Bank of America, say, will make it if Citi didn’t?
The nationalization of Citi makes the failure of the next-weakest large bank vastly more likely for all of the above reasons. But if BofA fails, the effect on the next weakest bank is even more dramatic.
Moreover, the effect plays out internationally. Citi and BofA are global financial institutions. If they become arms of the U.S. government, what kind of pressures get brought to bear on UBS? And, given that UBS is too big for Switzerland to bail out, what happens then?
Basically, if you’re going to go down the path of nationalization, you’re going to go very far down that path. You’re not going to take over the “weakest” players. You’re going to take over all the large players. And that, more than fear of scare words like “Socialism,” is the real reason (I suspect) why the powers-that-be remain reluctant to embrace the nationalization solution flat-out, preferring instead to back into it in ways that will prove more costly to the taxpayer and less “fair” to the variety of stakeholders in our banking system.