Sachs's Nationalization Idea

Jeff Sachs has a slightly peculiar idea for nationalizing banks, which he calls "contingent nationalisation". As best I can work out, it involves the government buying up toxic assets at par, and then selling them off over the course of a year or two; any losses then have to be made up by the bank in the form of new equity. If that means the government becomes the new majority owner of the bank, then so be it. But I see two big problems with this idea.

One problem is that banks can't simply issue or raise that kind of equity, largely because they're (feared to be) insolvent. What's more, although Sachs talks about the bank becoming "wholly owned by the taxpayers" if it does turn out to be insolvent, it's not clear how his mechanism would achieve that, since it involves only diluting existing shareholders rather than wiping them out entirely. (This problem is exacerbated by the fact that Sachs wants the dilution to happen piecemeal, rather than all at once, which means the government is going to end up diluting itself.)

A bigger problem is that Sachs's scheme constitutes a massive government bailout of all banks' unsecured creditors and preferred shareholders. See how he introduces it:

Consider a bank balance sheet with 100 in assets at face value, 90 in liabilities, and 10 in shareholder equity. For simplicity, suppose that the 90 in liabilities are in government-insured deposits.

I think that by "for simplicity" here Sachs really means "for the sake of everybody in the capital structure except the shareholders". Sachs's model basically assumes that the government has already guaranteed all of the liabilities of the bank. But of course that's not the case at all: there are hundreds of billions of dollars out there in unsecured debt and preferred stock, as well as hundreds of billions more in secured debt. If Sachs wants a government guarantee on all that private-sector paper, which is currently trading at very wide spreads, he should come out and say so. But surely a much better solution would be to somehow bail in the bondholders and preferred shareholders of insolvent banks.