I have to admit: sometimes it is very hard to stay serene. And now is one of those times. When all around you seemingly intelligent people really do believe that nationalizing banks before they have issues is a good idea, then yes, I do lose my patience.

Felix Salmon is almost foaming at the mouth and touts this idea exclusively in most of his posts of late. He quickly dismisses two reasonable alternatives, namely the aggregator bank or the government reinsurance.

Let’s respond to what he said: According to him the aggregator bank doesn’t work, because if it bought assets at the price they’re really worth then the “insolvent” seller banks would still be bankrupt. This is true if and only if a) the aggregator bank pays the current depressed market price or lower, and b) the seller bank sold a substantial amount of their assets today at depressed prices. But what if they only sold off some assets to reduce exposure and take the risks on others, paying out actual realized losses over time as they materialize? Hmm… And what if the aggregator bank believed that AAA rated CMBS tranches with 30 % credit support should be valued higher than 60 cents on the dollar?

He then talks about the difficulties of establishing a fair price. Well, isn’t this the crux of the matter? Why is Felix assuming that current prices are fair prices? They can either be lower or higher. If they’re higher, then where is the problem? And even if they were lower, most of these assets do not mature TODAY, so any losses would be spread out over the life of the loan. So why would you force banks to realize these losses today? On what grounds?

Many of these problems also apply when you look at his dismissal of the reinsurance idea. Once again he assumes that current depressed prices are fair. And once again he assumes that banks would shed all their assets at current distressed marks. Why would they do that again? He doesn’t answer.

No, to Felix the best idea really seems to be to wipe out common stockholders simply because based on dire default rates that all materialize TODAY tangible common equity is gone, regardless whether loans are still performing. This kind of thinking only makes sense when you’re short.

The solution indeed is much simpler: instead of deliberating if one or another approach is the best, do them all. When banks become illiquid or insolvent, nationalize them. If they want to sell assets, set up the aggregator bank and try to do a good job valuing those assets based on conservative assumptions. And if they want to reinsure parts of their portfolio (and thus preserve some of the upside), let them do that at reasonable rates. To avoid the taxpayer footing the bill you could even say that if actual losses exceed assumed losses the bank is still on the hook, but with a somewhat generous payback period (including interest of course).

But what if the government is worried about banks cutting back lending and therefore want to extend unreasonable loans to businesses or consumers? Well, they do not have to force banks or take them over to fix this issue. All they need to do is set up their own bank and offer loans similar to agency mortgages through other banks. Then banks who don’t want to lend to uncreditworthy people and instead delever can do just that.

Common sense. What a concept. Look it up in the dictionary, Mr. Salmon.

P.S.: Here is a good post from the WSJ regarding the current opportunities in banks.