Time for the Government to Stop Subsidizing Shareholders of Insolvent Banks

That is what Andrew Rosenfield argues for in this extremely cogently argued piece, and I agree with him. He makes a number of points about the bailout that I hadn’t heard before.

Rosenfield ends the article with the following sage words:

The present practice of subsidizing shareholders and debt holders of large insolvent bank holding companies is unprecedented, improper, and unwise. It is time to take strong capitalist action — and that requires wiping out the existing owners of the insolvent banks and giving the system much needed new equity capital, which, at this time, can come only from the government.

David Pearson

It's time for FDIC to tell bank shareholders they have no equity and they are now 'out'. And then turn things over to the bondholders. And if the bondholders can't make it work, shut the bank down.

The sooner, the better. Time's a wastin'.


It seems the Tim G agrees. Not only the stress test but imagine if a bank doesn't attract private investors to take their garbage or if investors require the government to take the risk ... that bank will not survive. It's politically impossible to agree to pump unknown tens or hundreds of billions into these entities, especially without any assurance that will work and while leaving the current managers and equity owners in place. The stimulus bill is so huge, can anyone imagine giving a blank check to the banks in that light?

But at the same time, we can't nationalize the banks without also engaging in messy political warfare - and having to work out terms, etc. that could be very costly. Better to go this route and let them fail the two tests.


I've received the following quote a few times as part of a forward message. Not sure of its authenticity (who can verify...?), but "new equity can only come from the government" sounds awfully like the end of the passage. Of course it ignore the fact that eventually the government will return the role of creditor to the banks... anyway:

"Owners of capital will stimulate the working class to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable.

The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to communism."

Karl Marx, Das Kapital, 1867

Don the libertarian Democrat

The only real moral hazard the banks and shareholders fear is nationalization. As well, the current arrangement merely continues the relationship between the financial sector and government that got us into this mess. Since that's what's been going on since September, I'm a little worried that people are just figuring this out. It indicates a serious misunderstanding of how our system works.

Phileas Fogg

I tried to verify that quote after being forwarded it.
I failed.

Google gave me this



The only thing I wish he would have added is a plan to break up the biggest banks into smaller units after seizure, to ensure that they will no longer be too big to fail.


I'm just not sure this is ever a good idea:

"The government then can install a new CEO of its choice, along with senior executive management."

The implications are frightening. The economics of executive attraction and retention are replaced by political interest.

Ron Force

#3--The purported quote from Marx has not been found in any of Marx's writings. Just another Internet hoax.


I wonder which party the new board and CEO would direct their bank's campaign donations to.

Joe Smith

We have a run on the banks. Nationalization is not the right answer. The whole real estate sub-prime mess is only a one or two trillion dollar loss - an amount the markets could absorb. Recapitalization / liquidity on a temporary basis with senior debt charging, say, interest one half a point above what the government pays is the right approach. (Plus prison for rather a larger number of Wall Street types.)

Joe Smith

A huge part of the systemic problem is the existence of derivatives including credit default swaps. I have seen no indication that government has tackled that problem. Personally I would prefer if governments simply declared default swaps to be illegal and unenforceable but at the least they should be forcing an unwinding of those positions and introducing serious regulatory oversight on derivatives going forward.

Avi Rappoport

One good way to think of it is the implications of the alternative: rewarding risky investments by removing the risk, thus allowing those investors both very high returns and complete safety.

Despite my retirement funds taking the hit, I am very much in favor of this. Risk should be real.


Many banks given a bailout were "Too big to fail", they and are shrinking to more managable sizes. The entire country is paying what few shareholders should.

Milton Recht

Andrew Rosenfield and the US Treasury are worrying about the wrong problem.

The US is not any better off or richer if the government places its own stock in banks for the banks' toxic assets. It just moves the toxic asset problem from the right hand pocket of a potential FDIC liability to the left hand pocket of a potential US Treasury (or Federal Reserve) liability. In either pocket, US citizens still owned the potential liability and will have to make up any future shortfall through paying taxes. Furthermore, the capital base of the banks will be the same through a recapitalization as through a delay in writing down the toxic assets. Therefore, the total lending by these banks will be the same and the US economy will not be getting any economic benefit after the government's investment in these banks. Insolvency does not affect a bank's ability to be a lender, but does call into question its ability to survive as a corporate entity.

A recapitalization of the large banks is an optical trick that allows the US government to say it will not close these banks down. Unless the government reorganizes the bank and wipes out the private investors with the chance that the government becomes the sole investor, a recapitalization protects the banks' current shareholders and bondholders.

Insolvent banks pose a threat to debt holders and shareholders who face a complete loss of their investments. Insolvent banks, also, pose a threat to depositors only if the bank's income and positive cash flow are insufficient to continue paying deposit interest, deposit withdrawals and fund new lending. The large banks that the government is thinking about salvaging have sufficient positive cash flows to continue to operate. Many of the toxic assets continue to have a positive payment stream. These banks also have many cash equivalent assets such as US Treasuries, which can be converted to cash to fund lending without increasing the banks' leverage ratios and without increasing the banks' need for further capital to make loans.

Write downs of toxic assets decrease capital and accounting income, but do not decrease cash flow and sometimes actually increase cash flow because of the reduction in taxes. Capital amounts due to regulatory minimum capital requirements do impact the ability to lend. Simply allowing banks to delay writing down toxic assets (or allowing them to amortize the loss over a long time period such as on a asset cash flow matching basis), would obviate any need for the government to recapitalize these banks. It would allow banks with positive cash flows to remain sufficiently capitalized to continue to lend.

Banks were once, until about 40-50 years ago, the primary source of lending and deposit gathering in the US. With the advent of greater direct access by corporations to capital markets, private equity, hedge funds, insurance companies, non-financial lenders and with mortgage and loan securitization, bank lending has declined from 40 percent in 1980 to about 22 percent in 2008. The downward trend will continue, as banks no longer hold the monopoly on lending and are not the most efficient or knowledgeable source about borrowers.

Similarly, these days a much greater share of corporations and consumers place their funds in alternatives to FDIC insured bank deposit accounts, such as money market funds, muni and corporate bond funds, direct investment into US Treasuries, corporate bonds, municipal bonds and stocks. Like lending, banks have lost their monopoly as funds gatherers. In fact, without FDIC insurance, these large banks probably would not have been able to continue to gather and keep their deposits as the banks increased the riskiness of their assets. Either the deposits would have left these banks or demanded an interest rate higher than the return on the banks' assets.

Whatever the government decides to do with the large banks, it will not change the total bank lending in the US, but it can meaninglessly transfer potential liability from the FDIC to the US Treasury. The US government should just allow the importance of these banks to the US economy to continue to diminish. The government and the Federal Reserve should continue to focus on reinvigorating the non-bank lending and securitization in the US, which are now, as have been for a while, the primary sources for loans to the US economy. The government should just give the banks the OK not to write the down the toxic assets and then focus on the real economic problem in the US of the lack of non-bank lending and securitization. Over time, the large banks will continue to lose their importance to the US economy and whatever is done to them at a later date will no longer be a major concern.



"...giving the system much needed new equity capital, which, at this time, can come only from the government."

I am not sure what you mean by agreeing to the statement.

Here is a question. Let's say you auction an insolvent bank, starting price being $0 and lowering the bid price to be negative (meaning removing some liability obligation). If the bank is too large, you could divide it into pieces and sell them. Do you think there won't be any bidder other than the US government?

Are you saying "no" to this question or "yes" but a temporary owner is necessary for the process to find new owners?


Yes. Ditto the car companies.

My message to them? You put yourself in the position you are currently in. Deal with it.

While hundreds of thousands trickle into the unemployment lines, the ones who CAUSED this mess should be there too.


The reality is that we are just one step above France right now, and that might even be debateable.

There are very few banks that are too big or too important to fail. And even those could be bought for pennies on the dollar by the government. The rest of the ailing should be allowed to shutter and money should be put into those that are stable. The government should spend most of their time and money working the 20% of the best and brightest, and let the other 80% end up where they end up.



Recapitalization is (almost) natural in a capitalist system. Old gray hairs used to talk about an invisible hand that guided the markets. When we are gray hairs we will be talking about a manipulating hand; a market calculated by risk with a baseball style backstop guart'd by the US. The similarity is that each concept presupposes each other.


How can you wipe bondholders out when they based what they thought to be wise and safe investment decisions on the rating agencies sloppy work?
When a financial institution is presented to you with AA, the only thing you can do is to hope there's enough honesty and competency to support that conclusion. Until 15th Sept 2008 that's what most of people believed.
Bondholders are morally entitled to a bail out.


We should go one step further. Some economists have said that an equity takeover of Bad Bank A will have the effect of weakening the business position of Solvent Bank B. People would choose the assurance of government backed Bank A, even if Bank B was in relatively decent shape.

This means we could potentially buy up banks like Bank B at less than present market value by telling them that they'll get stranded unless they get on board with us. We could use our power to make money off these ninnies.