Wednesday, January 21, 2009

Obama Administration Day One: Socialism is already on the march!

The Wall Street Journal is reporting this morning that the Obama administration is rushing to get more assistance to troubled banks…

Shares of the biggest names in American banking plunged Tuesday as some investors feared that the government would need to nationalize the most deeply wounded financial institutions, wiping out stockholders.

The hours-old administration of President Barack Obama is expected to move swiftly to try to stabilize the financial system by pumping more capital into weakened banks and buying bad assets. Nationalization appears to be a last resort, but other options on the table move the U.S. in that direction. In one idea under consideration, the government could buy convertible securities from financial institutions, an approach that could ultimately leave the government owning large chunks of many firms' common shares.

The scary part of that is the word “nationalization”. What does that mean?

James Smith, CEO of Webster Financial Corp., a Waterbury, Conn., lender whose shares fell 21% Tuesday, said investors seem rattled by the prospect that the government could nationalize banks and wipe out shareholders in the process. He said nationalization will likely be a last resort. "That last resort doesn't seem so far removed at this point, particularly because of valuations," Mr. Smith said. "There's a lot of fear out there."
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U.S. officials are wary about taking the most extreme step -- nationalizing banks altogether -- worried about the government's ability to run them. The challenges of running Fannie Mae and Freddie Mac, the two large mortgage-finance firms the government took over last fall, are seen as evidence of that.

But as the market value of many firms evaporates, they may be left with no other alternatives to raise cash. From a political standpoint, there's not much support for protecting shareholders of banks when the government is pouring billions of dollars into the institutions and in some cases guaranteeing their debt.

So in essence, if you own shares of stock in a bank my understanding is that your shares would lose all of their value. That would permanently wipe out a lot of wealth. If you own, as I do, shares in banks that have lost a ton of value the hope is that they will recover their value over time. But if I am understanding this correctly, nationalizing these banks means that Uncle Sam takes over and you lose your equity forever. That is not going to hurt just the fat cat bankers in pinstriped suits, smoking cigars. Lots of pension funds, mutual funds and individual investors also invest in banks and they will lose a ton of money. How confident do you feel that the same government that let Fannie Mae and Freddie Mac collapse and that handled the Hurricane Katrina aftermath will make super-great bankers? Me, not so much.

I do not think that there is not an easy answer to this problem. The fact remains that banks are one of the economic drivers of our economy, especially since we are so dependent on credit to fuel the economy. If you want to buy a car, you typically need access to credit. If you want to buy a house, same thing. Because people can’t get credit, they cannot buy and sell houses freely, leaving more and more houses in foreclosure. People can’t buy cars, so the auto plants sit empty. As I drive around the Detroit metro area, it is weird to see all these huge auto plants sitting with empty parking lots. It is going to take a lot more than empty rhetoric about “hope” and “change” to fix what ails us, it is going to take some backbone and a willingness to let things get worse before they get better. Otherwise the economic downturn will turn into a permanent state of malaise, dumping trillions of dollars in debt onto future generations and leaving much of our nation’s economy in the hands of the Federal government which will be disastrous. Some other nation will eventually fill in the vacuum whether China or India or some as yet unseen future economic power. If we abdicate control of the economy to the government, we will go the way of Western Europe as a fading power.

I would say that I got out of banking just in time.

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