Bankruptcy

Fed Considering Quiet Nationalization of Banks?

By J. Michael McBride

At the same time as most of the proposed “solutions” to our current economic melt down include increasing the power of the Federal Reserve, an article appears today that states that the Fed may be considering a “Nordic style nationalization” of US institutions. In particular, the Fed is attempting to come up with a solution which allows the central bank to save a bank or institution, but without the huge undeserved payoff to shareholders of that broke institution (see, Bear Stearns bail out where the shareholders threatened to scuttle the bail out in order to obtain a higher price for their equity shares ... in the insolvent company).

Quote: The US Federal Reserve is examining the Nordic bank nationalisations of the 1990s as a possible interim solution to the US financial crisis....

It is understood that Fed vice-chairman Don Kohn remains very concerned by the depth of the US crisis and is eyeing the Nordic approach for contingency options.

Scandinavia's bank rescue proved successful and is now a model for central bankers, unlike Japan's drawn-out response, where ailing banks were propped up in a half-public limbo for years....

While the responses varied in each Nordic country, there a was major effort to avoid the sort of "moral hazard" that has bedevilled efforts by the Fed and the Bank of England in trying to stabilise their banking systems.

Norway ensured that shareholders of insolvent lenders received nothing and the senior management was entirely purged. Two of the country's top four banks - Christiania Bank and Fokus - were seized by force majeure.

"We were determined not to get caught in the game we've seen with Bear Stearns where shareholders make money out of the rescue," said one Norwegian adviser.

"The law was amended so that we could take 100pc control of any bank where its equity had fallen below zero. Shareholders were left with nothing. It was very controversial," he said.

Stefan Ingves, governor of Sweden's Riksbank, said his country passed an act so it could seize banks where the capital adequacy ratio had fallen below 2pc. Efforts were also made to protect against "blackmail" by shareholders....

The tough policies contrast with the Fed's bail-out of Bear Stearns, where shareholders forced JP Morgan to increase its Fed-led rescue offer from $2 to $10 a share. Christopher Wood, chief strategist at brokers CLSA, says the Fed's piecemeal approach has led to "appalling moral hazard".

"Shareholders have been able to lobby for a higher share price only because the Fed took over the credit risk on $30bn of the investment bank's dubious paper. The whole affair also amounts to a colossal subsidy for JP Morgan," he said.

Here is a link to this interesting article: http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/03/31/cnfed131.xml

Michael

Full post as published by Texas Lawyer Blog on March 31, 2008 (boomark / email).