Geithner Plan as Prelude to Nationalization

Nouriel Roubini (aka "Dr. Doom") has an interesting post about the Geithner plan (h/t Publius). He writes:

I see the Geithner plan as being relevant only to banks that are solvent. For those that are found - after stress tests - to be insolvent I see as the proper solution - -as I have widely written - to nationalize them and thus clean them up to prepare them for re-privatization.

The stress test should do a triage between banks that are illiquid and undercapitalized but solvent given the provision of capital and liquidity and those that, under a reasonable stress scenario are effectively insolvent. Those that are insolvent should be nationalized.

Those that are solvent will still have many toxic assets that need to be disposed of; and the Geithner plan provides a way to properly dispose of the toxic assets of solvent banks. So my partial support of the Geithner plan - with all the appropriate caveats regarding forcing banks to sell toxic assets and accepting the results of the auctions - is consistent with the complementary idea of nationalizing the insolvent financial institutions.

At the very end of the post, he writes:

In conclusion the Geithner plan is not an alternative to nationalization: insolvent banks should be nationalized and the Geithner plan should not apply to them. But solvent banks still need to have their toxic assets disposed of; and for this banks the Geithner plan provides a solution that - all in all - is better than the alternative. Those who dont like the Geithner plan on the basis that they prefer nationalization are right - as i agree - that the insolvent banks should be nationalized. But they usually dont give an explanation of how they would dispose of the toxic assets of solvent banks. They seem not to like the Geithner plan because it would provide a subsidy to the investors. But ensuring participation of private investors in the risk and in the price revelation is worth that subsidy. Otherwise those who criticize the Geithner plan as a solution to the toxic assets of solvent banks should come up with an alternative that works and that is less costly to the government than the Geithner plan.

This strikes me as exactly right. There are two kinds of banks out there: the ones that would be solvent even if their toxic assets were reasonably valued and those for which any reasonable valuation of these assets would reveal them to be hopelessly insolvent. Regardless of how we deal with the truly insolvent banks, it's in our interest to clear these assets off the books of the solvent banks and give them a clean bill of health. The Geitner plan provides a serviceable mechanism for doing that.

Moreover, I'd go one step further than Roubini. Presumably, the solvent banks would want to participate in the Geithner plan, sell their assets at whatever the bid price is, and be declared healthy and sound. The insolvent banks, however, will be very reluctant to participate in the bidding process and may well reject the final bid price (knowing that if they sell at that price, they'll be forced to acknowledge their insolvency). In this way, the Geithner plan itself could prove to be the most effective "stress test" the government could employ. The banks who won't sell their assets (or value them) at the bid price will be presumed insolvent.

In this way, the Geithner plan could serve as a prelude to nationalization, a way of sorting the viable banks from the insolvent ones and proving to the public and the market that nationalization of the insolvent banks is necessary.