Why shouldn't we nationalise banks?

Like the weather, everyone complains about banks but does nothing about it.

Everyone complains about the weather, the American humourist Will Rogers once said, but no one ever does anything about it. Were he alive today, the Depression-era Rogers could say the same about America's banking crisis, although it would not be all that funny. True, the administration of Barack Obama has an ever-evolving plan for rescuing troubled creditors, nearly all of which are thought to be insolvent by celebrity economists such as Nouriel Roubini.

The government has given the nation's 19 largest banks six months to evaluate the extent of their losses under two scenarios, the worst of which is the rather sunny assumption that the US economy will suffer at most a 4 per cent year-on-year contraction in the second and third quarters of this year. At the end of this period of so-called "stress testing", the most troubled institutions may then issue a convertible bond to the Treasury in an amount deemed sufficient for them to restructure themselves.

If the private sector does not settle up after another six-month period, the government will step in with new funding. Given the hopeful news last week from major banks, led by Citigroup's announcement that it would no longer need government funding, it is tempting to think the worst of the credit crunch is over. But does anyone really believe that we are even close to the bottom? According to Goldman Sachs, the US financial sector faces US$460 billion (Dh1.68 trillion) in credit losses.

The US banking sector is so highly concentrated, with only four banks accounting for two thirds of the total assets held by the nation's commercial lenders, that the failure of just one of them would be disastrous. Of course, the picture would look a lot brighter if the lending industry was allowed to liberate itself from the discipline of mark-to-market accounting, which obliges them to base asset valuations on market prices.

Barney Frank, the chairman of the House Financial Services Committee and usually a Wall Street adversary, agrees that attempts to value distressed products such as mortgage-backed securities according to their last sale price is futile in such an illiquid market. Mr Frank told financial regulators last week that he wanted to relax accounting rules and he requested guidance from them on how to go about doing it.

He was praised by Edward L Yingling, the president of the American Bankers Association, who lamented the "systemic risk that accounting standards can have on the economy". Steve Forbes, the outspoken conservative publisher, recently condemned mark-to-market accounting in a Wall Street Journal opinion piece as "the principal reason why our financial system is in a meltdown". Really? A plurality of smart economists might attribute the crisis to the cult of deregulation - established during the Reagan administration and venerated ever since - that turned America's credit markets into casinos and confidence games.

Attempts to dress up the roguishly under-regulated markets by scuttling the few rules that remain will most certainly fail. Even Timothy Geithner, the Treasury secretary, cautioned the Senate Budget Committee to "be very careful not to do things that would erode confidence in the people's ability to assess the risks in exposure to a bank". Good advice, but a generation late. The debate over mark-to-market accounting is a distraction from the heavy lifting the White House and Congress have been evading, but which will eventually become unavoidable.

In a hole this deep, it is inane to get hung up on finding the "right price" for underwater assets. Instead, the government needs to assume managerial control of the country's weakest banks, restructure their portfolios, and sell them - in pieces, if necessary. This is known in beginners' economics as "nationalisation", something no politician, regulator or creditor wants to see happen on his watch.

But if the federal government's response to the near-collapse of the mortgage giants Fannie Mae and Freddie Mac, the insurance giant AIG, and Citigroup is not de facto nationalisation, what is? In testimony to Congress late last month, Adam Posen, an economist, told politicians what they should avoid doing, and it sounded chillingly familiar to what the Japanese government did in the 1990s before it finally began nationalising failed banks in 2002.

Leaving bank restructuring to the same creditors who have a vested interest in tinkering at the margins, Mr Posen said, "leads to a worse outcome... The government ends up overpaying for some assets in terms of guarantees and subsidies versus simply buying them at today's low values, but only manages to sell the more liquid and attractive upside assets. "The US taxpayer gets left with the lower future return lemons, while paying for the privilege of having private investors get the assets with the most upside potential."

Mr Posen's testimony echoed what crisp minds, from James Baker, the former US secretary of state, to Alan Greenspan, the former Federal Reserve Bank head, have been saying for weeks now: it is time to nationalise the country's ailing creditors. And why not? Why should Washington pander to the very bankers who got us into this mess in the first place? [e-mail]