Uncle Sam Bank Not Open for Bank Business, Yet

by Emily Kaiser and Pedro da Costa

WASHINGTON/NEW YORK  - Just as Wall Street was coming to grips with the notion that bank nationalization might be inevitable, U.S. officials have come out strongly against an idea that strikes at the heart of America's capitalist model.

This does not mean the banks will escape Uncle Sam's grip. Many analysts predict that, with the economic outlook going from bad to worse, prospects are dim for reversing bank sector losses that have all but paralyzed global credit markets.

"There is little precedent for digging out of a financial crisis this deep without putting several major financial institutions through some form of receivership or bankruptcy -- call it nationalization if you will," said Kenneth Rogoff, a Harvard University professor and former chief economist of the International Monetary Fund.

Both the White House and top U.S. policy-makers still hope to avoid that course. Federal Reserve Chairman Ben Bernanke laid out a strong case against taking over banks, arguing that governments are notoriously poor at running private-sector companies, and that seizing a large, global firm with a host of complex contracts and securities could spawn legal headaches.

"I don't see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn't necessary," Bernanke told the Senate Banking Committee on Tuesday.

Yet with banking sector losses totaling at least $1 trillion, a figure that some believe will double before all is said and done, some economists say there is simply no alternative.

Highly respected figures from opposite ends of the political spectrum -- ranging from former Fed Chief Alan Greenspan to Nobel economist Joseph Stiglitz -- have argued as much.

Indeed, some note that the erratic behavior of the stock market, which this week touched its lowest level in 12 years, is evidence that business as usual simply won't fly.

"The comments from Washington made it appear that Washington is comfortable with the status quo with regards to the banks," said Daniel Alpert, managing director at Westwood Capital, a small investment bank. "Business isn't comfortable with the status quo -- the business community needs the banks to get back to business and doesn't care who owns them."

WILD, WILD BANKS

Of course, many Americans are not comfortable with the prospect of a government-run financial sector.

"The emotional nature of the reaction is purely American," said Douglas Elliott, a fellow at the Brookings Institution think tank and a former JPMorgan investment banker.

"We have all been taught of the glories of individual achievement and of the markets as a way of channeling our individual striving to also achieve joint goals. I don't see John Wayne working for the Federal Bank of the West."

U.S. Senator Jim Bunning famously ranted against government intervention in private markets last year when then-Treasury Secretary Henry Paulson asked Congress for an unspecified amount of money to support struggling mortgage finance companies Fannie Mae and Freddie Mac.

"When I picked up my newspaper yesterday, I thought I woke up in France. But, no, it turned out it was socialism here in the United States," Bunning, a Kentucky Republican, said at a July 2008 hearing.

Nor would bringing major banks under government ownership be a simple task. The precedent often cited is that of Sweden, which took over its banks after a crisis in the early 1990s and successfully avoided the sort of prolonged downturn that plagued Japan for much of its "lost decade."

Opponents of nationalization note that the United States is much larger than Sweden, with many more globally important banks whose relationships might be too entwined to untangle.

"One of the biggest concerns of nationalization is that it will be contagious -- every time one bank is nationalized there is the risk of triggering panic among the counterparties of the weakest remaining banks," Elliott said.

There are also the tricky questions of whom the government might hire to run the banks and how officials would ensure that politics did not interfere with lending decisions.

Still, nationalization would serve two purposes. First, it would help generate confidence that the banking sector has the absolute backing -- rather than just a verbal nod -- of the U.S. Treasury.

Second, it would demoralize top bank managers in a way that might ensure they are not rewarded for their mistakes with huge swaths of government cash.

"It is an acknowledgment of a breakdown in the private sector," said Nigel Gault, director of U.S. economic research at Global Insight.

Nationalizing banks is nothing new, even for the United States. Regulators have had the authority for decades to take over banks on the brink of insolvency.

Some are quickly resold, as in the case of IndyMac which was taken over by the Federal Deposit Insurance Corp last year. Others take years to return to private hands, like Continental Illinois, which was taken over in 1984 and stayed under government control for seven years.

Institutions the size of a Citigroup (C.N) or a Bank of America (BAC.N), the two banks often mentioned when the issue of nationalization is raised, are altogether different beasts. But as President Barack Obama noted in his address to Congress on Wednesday, radical problems call for bold solutions.

The question is how this administration defines bold.

Editing by Jonathan Oatis