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Time to nationalize undercapitalized banks

Hank Paulson's plan to spend $700 billion of your money to buy some share of the $13 trillion worth of toxic waste -- in the form of mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs) makes little sense. It involves a reverse auction in which the Financial Institutions (FIs) that hold this junk bid to see who can sell it to the Treasury for the lowest price. The FI's have no incentive to participate in this scheme because to do so would lead to big write-downs and leave a capital hole in their balance sheet that they can't fill.

The basic problem here is that banks lack capital. The simple solution, which occurred to me this morning after reading an op-ed piece by Paul Krugman, is for the government to buy the banks and help them raise the capital they need so they can resume lending. There is so much political damage from the current catastrophe that nationalizing the banks as I propose really won't hurt that much more. I am not sure how much it will cost -- but we've already nationalized Fannie, Freddie and AIG so why not make a list of all the under-capitalized commercial and investment banks and let the government take them over.

Compared to the $700 billion that Paulson wants for his wacky plan, we could buy up Citigroup (NYSE: C), Morgan Stanley (NYSE: MS), and Goldman Sachs (NYSE: GS) for about $200 billion (roughly 10% over their current market value). In light of the $800 billion spent so far, that $200 billion would be chump change. And if the government runs them right, it can sell their shares back to private investors once we get through this period of "adjustment" and make a nice profit for taxpayers.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns Citi shares and has no financial interest in the other securities mentioned.

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Last updated: November 21, 2008: 10:26 PM

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