The IndyMac Example: Nationalized, Cleaned Up, Sold

indymac.jpgYesterday, the Federal Deposit Insurance Corp. (FDIC) successfully completed the sale of IndyMac bank, eight months after it was nationalized following catastrophic losses due to subprime mortgages. The bank’s 33 branches will reopen today as branches of OneWest, a Pasadena-based bank.

Even though it cost more than originally estimated, the successful nationalization and re-privatization of IndyMac — the fourth largest bank ever seized by federal regulators — shows that taking over troubled financial institutions, clearing them of their troubled assets, and selling them back to the private sector can be done. As Stephen Gandel wrote in Time:

For the government, the IndyMac sale provides a shining example of how takeovers can work, at a time when the Obama Administration may soon begin pushing for more nationalizations…The government is in the process of stress-testing the nation’s largest banks as part of Treasury Secretary Timothy Geithner’s plan to fix the ailing banking sector. And many think the outcome of those tests could lead to more takeovers.

We’ve been arguing that nationalization is the best way to handle zombie financial institutions. However, in order for leviathans like AIG and Citigroup to be nationalized and wound down, some mechanism — different from that employed by the FDIC — needs to be created. As FDIC Chairman Sheila Bair explained to the Senate Banking committee yesterday:

The problems of supervising large, complex financial institutions are compounded by the absence of procedures and structures to effectively resolve them in an orderly fashion when they end up in severe financial trouble. Unlike the clearly defined and proven statutory powers that exist for resolving insured depository institutions, the current bankruptcy framework available to resolve large complex non-bank financial entities and financial holding companies was not designed to protect the stability of the financial system.

The Obama administration and Congress are reportedly “rushing to write legislation that allows the federal government to take over and unwind the businesses of a large financial institution,” which hopefully means that nationalization is at least on their radar. Thus far, as Paul Krugman noted, the steps taken by the administration make it seem like they think the crisis “can be undone with a bit of financial engineering,” which could be a very flawed assumption.

Plus, nationalization would allow the federal government to prevent bailed-out institutions from, say, paying out huge bonuses or — as Citigroup is currently doing — spending $10 million on new executive offices while lobbying against bonus-restricting legislation.