dangerous and promising moments. The President will need to be front and center in explaining and supporting the action, while the appropriate regulators and Treasury officials each play their proper roles. Ideally, key Congressional leaders would quickly show their support.
Step 9b: Shore up confidence in the other banks Nationalizing one or more of the nation’s largest banks is likely to catch a number of observers by surprise. There is a real risk of a “run” on those of the remaining banks that are perceived to be weaker. It is possible that there would be a run by depositors, although the FDIC retains great credibility and nationalization may be seen as effectively adding a full government guarantee of deposits, whether or not such an action is announced. The greater risk is that there is a chain reaction of panic. The share prices of other weak banks may plummet from already low levels. In the past year or so, we have seen such price declines lead to withdrawal of support from other key constituents, including trading counterparties, creditors, and customers. The negative publicity surrounding those actions might lead to deposit runs, which could be exacerbated by the feeling that the newly government‐owned banks are a safer place to keep money.
Even if such a panic did not cause additional bank failures, it would likely further dampen lending and other risk‐taking at the remaining banks. The weaker ones could become totally preoccupied with preserving their independence by shoring up their capital ratios and otherwise reducing their risk exposure.
It is therefore very important that the government make clear its comfort with the remaining large banks. This should not extend to guaranteeing immunity from a future seizure, but should provide real confidence that such an action is unlikely to be necessary. This could be done in several ways, including:
Providing a clear rationale for which banks survive and which are taken over. The government should be as open as possible about the criteria that were used to determine which banks were seized. As noted earlier, there needs to be a wide “firebreak” between the nationalized banks and the next weakest bank. This clarity may require providing more information about the valuations that were applied to the “toxic assets” and other assets, especially loans, which were on the nationalized banks’ balance sheets. Without sufficient clarity, it would be hard to know whether the remaining banks were really viewed as having sufficient capital or whether too much of their stated capital was seen by the government as illusory.
Injecting capital. One way of widening the “firebreak” would be to add new government capital to the weakest remaining banks, so that their capital ratios and other indicators of their health would more clearly differentiate them from the just‐nationalized banks. A related idea is for the government to stand ready to add capital, much as they have offered with the Capital Assistance Program tied to the stress tests currently being undergone by the banks. A key obstacle to either approach is that there is not sufficient remaining authorization of TARP money for this to be credible. It would be necessary to go back to Congress for larger authorizations in order for this approach to provide the needed confidence.