Bank Fix Lacks Consensus

Bank regulators on Monday attempted to calm fears about their response to the financial crisis, but no consensus on to best fix the malaise exists.
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Bank regulators on Monday attempted to wipe away some of the uncertainty created by the government's response to the financial crisis, as analysts, economists and other experts lacked consensus on how to best fix the malaise.

Five regulatory agencies, including the Treasury Department, Federal Deposit Insurance Corp. and

Federal Reserve

issued a joint


assuring investors that explicit nationalization of the banking system was not an option on the table. The fear that banking giants


(C) - Get Report


Bank of America

(BAC) - Get Report

could be taken over by the government sent the stocks spiraling on Friday, before both companies and the

White House

calmed nerves, stemming a wider market selloff.

The regulators said the federal government intends to continue to provide capital for institutions that cannot get money from the private sector in exchange for preferred shares, to be converted into common equity over time.

"Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands," the regulators said.

Shares of Citi and BofA rallied on the implicit assurance that they will remain in private hands to some degree. Though their slide last week was less severe, shares of other major banks like

JPMorgan Chase

(JPM) - Get Report


Wells Fargo

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also rallied Monday.

While investors might be more confident that banks will remain in the private sector, there is still a labyrinth of uncertainty about the future of major institutions. Investors don't know what lurks within banks' balance sheets, whether anyone will buy their

troubled assets

, what firms will survive the government's

stress tests

, how much shareholders will ultimately be diluted via government aid, how much more pain the economic contraction will bring, and when the losses will end.

Nor does there seem to be a consensus opinion on the best solution for the banking crisis. Analysts, economists, academic experts and talking heads have a variety of opinions, some motivated by politics rather than efficacy.

There is the outright nationalization camp -- some call them socialists -- who say that path will be quicker, cheaper and ultimately less painful. They advocate taking over technically insolvent banks, stripping out the bad assets, and putting all of the pieces back into private hands at negotiated prices. This solution would probably wipe out shareholders, and perhaps debt holders, but protect taxpayers and depositors under FDIC limits.

The polar-opposite camp favors a free-market solution in which the government stops helping private companies completely, and lets insolvent banks fail. This solution is not likely to occur, but would have essentially the same results for investors, debt holders, taxpayers and depositors.

Still others say that the Obama administration is handling the banking crisis in a fair and adequate manner: Providing capital for struggling banks, receiving hefty dividend payments for preferred shares, and leaving open the option for private investors to step up to the plate. Advocates of this strategy argue that the government is notoriously bad at overseeing bank operations. And while the failure of thrifts like



Washington Mutual

, were relatively quick and painless, a giant bank like Citi or BofA would be much more complicated and difficult to handle.

"The government just isn't good at doing this kind of thing, and everyone knows it," says Jeffrey Curry, a managing director in the Vienna office of the consulting firm LECG. "I think there's just too much going on in terms of trying to piecemeal out assets and liabilities in portfolios and mete them out individually. They're just too big to fail."

Curry, who oversaw parts of the savings and loan bailouts in the 1980s and 1990s as an assistant director at the Office of Thrift Supervision, believes the government -- as a major shareholder -- should put new management in place, and make it a top priority to remove troubled assets from banks' books.

Others have outlined dangers of direct nationalization of the banking industry. On Monday morning, Rochdale Research analyst Richard Bove mocked the idea of a speedy return to private hands, saying that even if banks were taken over "for only 15 minutes," it would entail "massive losses" by investors, lenders and depositors whose funds run above the FDIC's $250,000 guarantee cap. Bove also believes the government would fail miserably at running a bank, crimping lending, creating uncertainty about employment and directing funds "to aid the poor" rather than stimulate the economy.

"Thus, nationalization would not only cause millions of Americans to lose trillions of dollars," writes Bove, "it would impose a system on the U.S. economy that would destroy its ability to recover for decades."

Fox-Pitt analyst David Trone also believes nationalization would "cause more problems than solutions" by hurting operations and repelling new customers and employees. Such a scenario would make it even more difficult to sell the business back into the private market, or for the firm to regain profitability in better times.

"If Citi is nationalized, all bank stocks are likely to get crushed in fear," Trone writes.

But is all this doom and gloom warranted? And is it better for the industry to hang in a matrix of uncertainty for months, as the government performs stress tests, formulates a distressed-asset purchase program, and continues to pump capital into ailing banks?

FBR Capital Markets analyst Paul Miller says no.


The quickest and lowest cost solution is for the government to close down troubled financial institutions, regardless of size, extract the toxic assets, and sell the good portions of these financial institutions to private investors as quickly as possible," he writes in a research report Monday. Miller supports the creation of a large "bad bank" entity that can manage or sell the troubled assets over time, and believes that the process would take a year or less for even the largest institutions.

While Miller characterized his view as "an adult conversation" about the banking sector, politics are likely to trump his argument, says Stuart Greenbaum, a professor of banking and finance at Washington University's Olin Business School. Free markets and capitalism are essential to the U.S. philosophy, he says. "It's anathema to nationalize. It's like socialized medicine."

Greenbaum, who represented the government on the board of large savings and loan institutions during the last banking crisis, does not support nationalization. He believes the government should better represent taxpayers by taking over board seats and exercising tighter control.

But he does acknowledge that by claiming massive ownership stakes, providing guarantees for bank assets, issuing loans for banks to operate in the capital markets and a host of other initiatives, much of the issue comes down to semantics. Similar to President Barack Obama's plans to provide health-insurance coverage for every American, it may not be called socialized medicine but it sure looks, walks and quacks like it.

"The point is that the government already by implication is the largest shareholder in Citi," says Greenbaum. "So what is the difference between having 51% of the stock and having control of the board of directors, and having 100% of the stock? Shareholders are already diluted to some degree -- the market cap on these things has gone to a tiny fraction of what it was. The question is whether they're going to be diluted or diluted to zero."