Bill Gross Warns Against Nationalizing Banks

“If you thought Lehman Brothers was a mistake, just standby and see what nationalizing Citi or BofA would do.”

Those dire words come from William H. Gross, who manages the largest bond mutual fund in the United States as the co-chief investment officer for the Pacific Investment Management Company.

In his March investment commentary, posted Tuesday on Pimco’s Web site, Mr. Gross weighed in on the great debate over whether troubled American banks should be taken over by the government. (In what we think is an unrelated development, he also talks about the disappearance of his mustache.)

Holders of bank shares, such as Citigroup and Bank of America, are watching the nationalization debate closely, because a government takeover would probably leave them wiped out, or at least severely diluted.

In arguing against nationalization, Mr. Gross takes aim at some notable figures — specifically Nouriel Roubini, the economics professor at New York University who predicted much of the current financial crisis; Christopher Dodd, the chairman of the Senate Banking Committee; and Alan Greenspan, the former chairman of the Federal Reserve.

All three of those people have recently suggested, to varying degrees, that while nationalization is usually to be avoided, temporarily taking control of some banks might be the best way for the government to calm the financial storm.

Not so, Mr. Gross says in his commentary, which is structured as a question-and-answer session before members of Congress.

“I think Roubini, Dodd and Greenspan haven’t thought this one through,” Mr. Gross says in his mock testimony.

Making reference to the much-discussed Swedish solution to that country’s banking crisis in the early 1990s, he continued: “The U.S. isn’t Sweden, and not just because our blondes aren’t au naturel,” he writes. “Their successful approach revolved around a handful of banks but we have 7,500, as well as many S&Ls and credit unions, which would have to be flushed into government hands.”

Instead, he says, Washington should focus on creating credit and preventing more home foreclosures.

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Of course, for a bond-fund manager like Mr. Gross, the issue is hardly just an academic one. Shareholders are sure to suffer in a bank nationalization, but holders of bonds might get hit as well — an event that Mr. Gross says would roil the credit markets even more.

He writes:

"Forcing creditors to take haircuts would undermine other financial sectors such as insurance companies and credit unions. The goal of future policy should be to recapitalize lending institutions while maintaining the basic infrastructure of credit markets. Outright nationalization and haircutting of creditors will do just the opposite."