Oh My God, Nationalization Is NOT Possible

I'm sorry, Simon Johnson's argument that the government should seize the worst banks (e.g., Citi, BofA), force a debt-for-equity swap over the weekend, and re-open them as well-capitalized entities on Monday, is really detached from reality. This is, in effect, the "temporary nationalization," or "managed receivership" argument that has become so popular among commentators. (Since everyone knows that Citi would be the first bank to be nationalized or taken into receivership if the government went that route, I'll focus my discussion on Citi.)

Let me try this again:

Nationalization of a bank like Citigroup is not possible.

Receivership is also not possible, even if Treasury's proposed resolution authority for major financial institutions passes.

Citigroup is an international financial institution. It has branches and subsidiaries in over 100 countries. As Justin Fox points out, of Citi's $755 billion in deposits, $515 billion are outside the US. In general, each of Citi's foreign offices is subject to the insolvency laws of the country in which it is located. If the government put Citi in receivership or conservatorship, most of these foreign countries would seize the assets of the Citi subsidiaries in their jurisdictions and begin their own bankruptcy procedures. Any legitimate claims the US has on Citi's foreign assets would be governed by a convoluted web of international agreements.

The complications don't end there. Citi has over 2,000 principal subsidiaries. The Treasury's proposed resolution authority—which is essentially a scaled-up FDIC resolution, with a few changes—doesn't apply to subsidiaries which are registered brokers or dealers, insurance companies, FDIC-insured depository institutions, hedge funds, investment advisors, or private equity funds. (I'm sure I'm missing some too, since I'm not a bankruptcy lawyer by any means)

The insolvency of registered broker-dealer subsidiaries is handled primarily by the Securities Investor Protection Corporation (SIPC) under a resolution procedure designed specifically for broker-dealer liquidations. Insurance company insolvencies are governed by state insurance regulations, and handled by state insurance authorities. Obviously, the FDIC handles insured depository institutions under its traditional resolution authority. The rest of the subsidiaries not covered by the Treasury's resolution authority are thrown into bankruptcy court.

And this is all before you get to the actual restructuring, which would almost have to take the form of an FDIC-managed conservatorship. The assets and liabilities that the FDIC ultimately takes into conservatorship would likely be badly mismatched on several levels, and would bear almost no resemblance to Citigroup's pre-insolvency assets and liabilities. Seeing as the only bank stupid enough to buy this kind of mangled, leftover balance sheet outright is .... umm, Citigroup .... the FDIC will have to do some serious restructuring. In all likelihood, that means bondholders will have to take haircuts. How did that work out with Lehman again? Oh, right. It caused an epic financial panic that almost brought down the global financial system. Good luck with that. Cheer up, though: you're almost a third of the way through the vaunted "temporary nationalization" process.

I won't bore you any further. Suffice to say that this doesn't even scratch the surface of the legal obstacles to nationalization or receivership. As I'm sure you can see by now, the idea that Citigroup can be taken into receivership, restructured, and recast as a well-capitalized bank all in one weekend, is borderline delusional.

The broader point is that no matter how well a Citigroup receivership works in a Paul Krugman or Simon Johnson hypothetical, in the real world it's not a serious option.