(The following is now available in the on-line edition of the Financial Times; link to original Martin Wolf article added here)
Sir, Martin Wolf’s excellent article on the pros and cons of nationalisation suggested, quoting Nouriel Roubini, that we could wait six months to determine how solvent US banks are before making decisions (“To nationalise or not to nationalise is the question“, March 4). This is possible but surely risky.
At Wednesday’s close, the junior subordinated debt of Citigroup (for example debt underlying the Citigroup XV 6.5 per cent Enhanced Trust Preferred Securities) yielded 27.6 per cent, and similar securities at many other large US banks yield high double digit amounts. With such yields on debt, anyone conducting business as a creditor with these banks must think twice. Why not withdraw the business to another safer bank, or just halt such business, until we understand the US government’s ultimate plan? If enough businesses and individuals take such actions, the core franchise of Citigroup and other similar large US banks could collapse. The government, six months from now, will be left with distressed bank franchises that are worth far less than they are today. At that point politicians and policymakers will probably determine it is only fair that creditors bear part of the cost, thus justifying the current high default risk priced into bank debt. This scenario, which is ever more likely as we wait, illustrates why authorities must take actions urgently.
A gradual disintegration of bank franchises will be met with more credit contraction and some new panics, thus deepening the recession and further reducing solvency of banks. The only credible solution is to embark immediately on a Federal Deposit Insurance Corporation-type intervention, recapitalisation, and early reprivatisation of US banks. The recapitalisation needs to be so large that it is near impossible to imagine an economic outcome where they fail in the next five years. That requires several trillion dollars, not the small sums left in the Trouble Asset Relief Programme and earmarked in the new US budget. Without these urgent measures, whether we nationalise or not, we are risking a highly undesirable outcome.
Peter Boone, Chairman, Effective Intervention; Centre for Economic Performance, London School of Economics, UK
Simon Johnson, Senior Fellow, Peterson Institute for International Economics; Professor, MIT Sloan School of Management, US