Bernanke: Nationalizing AIG ‘Would Have Been Far Preferable’ To The Current Situation

[ProSense]

Bernanke: Nationalizing AIG ‘Would Have Been Far Preferable’ To The Current Situation

Today, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner testified before Congress regarding the AIG bonus debacle. In his opening statement, Bernanke expressed remorse that AIG was not just nationalized:

If a federal agency had had such tools on September 16, they could have been used to put AIG into conservatorship or receivership, unwind it slowly, protect policyholders, and impose haircuts on creditors and counterparties as appropriate. That outcome would have been far preferable to the situation we find ourselves in now.

Indeed, a lot of the AIG mess could have been prevented if it was just nationalized at the beginning. Instead, it’s been kept alive by infusion after infusion of federal funds, without the government ever exercising any of the control that should come from an 80 percent ownership stake. As Kansas City Fed President Thomas Hoenig pointed out, we’ve simply nationalized institutions “piecemeal, with no resolution of the crisis.”

Bernanke’s wider point is that there is no formal process that currently exists for nationalizing huge, complex financial institutions. According to a Washington Post report, the administration is well aware of this, and is considering a plan that would grant Treasury such authority:

Besides seizing a company outright, the document states, the Treasury Secretary could use a range of tools to prevent its collapse, such as guaranteeing losses, buying assets or taking a partial ownership stake. Such authority also would allow the government to break contracts, such as the agreements to pay $165 million in bonuses to employees of AIG’s most troubled unit. The Treasury secretary could act only after consulting with the president and getting a recommendation from two-thirds of the Federal Reserve Board, according to the plan.

According to Reuters, the FDIC has also “hinted it could take on that job, with Chairman Sheila Bair saying recently that the agency’s model for failed banks works well.” Either way, the change would have to be passed through Congress.

Nationalizing these giant firms would not be easy or inexpensive. But, there is not much else that can feasibly be done with giants like AIG or Citigroup — they’re too-big-to-fail and in no shape to carry on as they once did. If nationalized, AIG and firms like it could be wound down and broken up, and hopefully a new regulatory framework will be implemented to keep firms from growing so large in the future.

FDIC Chair Sheila Bair (PDF)

In the case of a bank holding company, the FDIC has the authority to take control of only the failing banking subsidiary, protecting the insured depositors. However, many of the essential services in other portions of the holding company are left outside of the FDIC’s control, making it difficult to operate the bank and impossible to continue funding the organization’s activities that are outside the bank. In such a situation, where the holding company structure includes many bank and non-bank subsidiaries, taking control of just the bank is not a practical solution.

If a bank holding company or non-bank financial holding company is forced into or chooses to enter bankruptcy for any reason, the following is likely to occur. In a Chapter 11 bankruptcy, there is an automatic stay on most creditor claims, with the exception of specified financial contracts (futures and options contracts and certain types of derivatives) that are subject to termination and netting provisions, creating illiquidity for the affected creditors. The consequences of a large financial firm filing for bankruptcy protection are aptly demonstrated by the Lehman Brothers experience. As a result, neither taking control of the banking subsidiary or a bankruptcy filing of the parent organization is currently a viable means of resolving a large, systemically important financial institution, such as a bank holding company. This has forced the government to improvise actions to address individual situations, making it difficult to address systemic problems in a coordinated manner and raising serious issues of fairness.

<...>

The current financial crisis demonstrates the need for changes in the supervision and resolution of financial institutions, especially those that are systemically important to the financial system. The choices facing Congress in this task are complex, made more so by the fact that we are trying to address problems while the whirlwind of economic problems continues to engulf us. While the need for some reforms is obvious, such as a legal framework for resolving systemically important institutions, others are less clear and we would encourage a thoughtful, deliberative approach. The FDIC stands ready to work with Congress to ensure that the appropriate steps are taken to strengthen our supervision and regulation of all financial institutions -- especially those that pose a systemic risk to the financial system.

[FrenchieCat]

1. Has Krugman commented on this yet?

Because I find it interesting that AIG has never been discussed in his nationalization scheme (if it has, I missed it)....in terms of getting nationalization through congress, and what that difficulty could involve. It is important in the scheme of things as so much of the bail out money went to them, and they seem to be the company under the microscope.

[soothsayer]

2. suck it, ben

[FrenchieCat]

4. What does that mean?

exactly.....

[soothsayer]

5. Dunno, I think it's a loss of confidence of those "in charge"

[pinto]

3. Thanks for the post. I missed a lot of the testimony this AM. n/t

[truedelphi]

6. This is a series of ridiculous statements.

There is no reason what so ever why AIG was not nationalized and/or put into receivership
last fall, or last week for that matter. Go to democrats.com/bailout and read th e article by dlindorff -- I will print out 4 paragraphs here:

"Wait a minute! Did I hear correctly? Did Treasury Secretary and
former New York Federal Reserve Bank screw-up Tim Geithner really tell
a House Financial Services Committee today that he needed “new powers”
to allow the federal government to take control of non-bank financial
corporations whose actions threaten the financial system or the economy
and “break them up”?

<snip>

Instead of doing the obvious—which would be to use the Fed’s and
the Federal Deposit Insurance Corporation’s powers to take over failed
banking institutions, break them up, and sell the healthy parts off to
stronger institutions—Geithner, Bernanke and the Obama financial team
have been pouring dollars into a group of zombie banks that are already
technically insolvent by any honest accounting standards, and that have
no chance of standing on their own. They are borrowing money at such a
prodigious rate that the Chinese government, America’s major creditor,
and the United Nations, are talking about the need to do away with the
dollar as the global currency, to be replaced by some basket of
currencies, and in the process virtually assuring that the US currency
will shrink dramatically in value, They are putting a colossal debt
upon future generations of Americans. And they are putting at risk all
the progressive goals that voters sent Obama to Washington expecting
him to enact: health care reform, energy reform, education reform, etc.

If Geithner and Bernanke think it is important, and appropriate, to
break up dangerously large and threatening enterprises like AIG, why
are they not even talking about breaking up Citigroup, Bank of America,
Wells Fargo, Goldman Sachs and other overlarge large banking firms?

Too big to fail should simply mean too big to exist. It’s that simple.
Not one more dollar should be spent trying to rescue these zombie
banks. In fact, they should be ordered to give back the hundreds of
billions of dollars that were already poured into them, most of which
they have reportedly simply invested in Treasury notes, since there was
nobody creditworthy who wanted to borrow the money. Then the regulators
should move in and shut all the big banks down, and begin the process
of tearing them apart. Those parts that are deemed hopelessly in debt
because of huge holdings of Credit Default Swaps and other toxic
financial products should be shut down, with shareholders and
bondholders taking the hit. The healthy parts—the banks with all the
deposits—can be auctioned off in pieces to smaller state and regional
banks. "