How Far Are We from the Swedish Bank Bailout Model: And What does the Market Know?

Andrew Sullivan, whom I'm liking more and more each day, has some interesting speculation about the Obama Bank Bailout 3.0 which casts the whole thing in a whole new light for me.

There are two lines of speculation about the direction the Obama team will go. One, the most likely, is the 'bad bank' model in which the government buys up the toxic assets and helps get the banks off their feet; the other is nationalization, in which the government applies a "stress test" on the largest most troubled banks, and for those that fail, declares them essentially insolvent, wiping out the shareholders and taking them over directly (aka the Swedish model).

Some feel the secret plan is to pursue the Swedish model covertly, since the country is not ideologically ready for it and the GOP will make tons of political hay over it. But most feel that Geithner won the debate with more politically populist elements in the Administration such as Emanuel and Axelrod ie., the Bad Bank model won. Hence, the Administration is likely to have to seek trillions more from Congress to buy up those assets and face the politically troubling question of what price to pay. When asked directly, Obama has ruled out nationalization, although not in a way that inspires confidence that he understands what nationalization would entail. More and more economists are coming forward with the stated realization that Nationalization is probably the way we have to go.

Observers of Geithner's weak performance this week commented that markets didn't like the vagueness and ambiguity of the plan, so they went down sharply on the day he spoke. But what if we look at this another way? What if the market's direction provides an indication by buyers and sellers of the way in which the Administration is likely to go. If indeed bank shareholders are worried that they are going to have a bad year, and if indeed there are a number of large banks that are essentially insolvent, then bank stocks' downward direction is not a statement that the Administration is being vague, but an expression of the likelihood that the Administration will eventually need to adopt the Nationalization strategy and wipe their value out. If I were an owner of bank stocks, I'd be really, really nervous right now.

It's in the Administration's strategic interest to keep the question open for as long as they can, so they can hedge their policy bets. But it's in the bank shareholder's interests for Obama to commit to the 'bad bank' model as quickly as possible. Here's hoping he chooses continued ambiguity and options over assuaging the shareholders.