Others talk of de facto nationalization, in which the government owns a sizeable chunk of the banks but not a majority, with all that connotes.

If it's in the NY Times, maybe they're considering it:

By DAVID E. SANGER

Published: January 25, 2009

WASHINGTON — Only five days into the Obama presidency, members of the new administration and Democratic leaders in Congress are already dancing around one of the most politically delicate questions about the financial bailout: Is the president prepared to nationalize a huge swath of the nation’s banking system? ( IS HE? )

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Speaker Nancy Pelosi has alluded to internal debate over whether large banks should be nationalized, while aides to President Obama have avoided the word and are looking into alternatives.( IT'S A SCARY WORD )

Related

Rescue of Banks Hints at Nationalization (January 16, 2009)

At Davos, Crisis Culls the Guest List (January 26, 2009)

Times Topics: Credit Crisis -- The Essentials | Economic Stimulus

Privately( IT'S NOT A SECRET ), most members of the Obama economic team concede that the rapid deterioration of the country’s biggest banks, notably Bank of America and Citigroup, is bound to require far larger investments of taxpayer money, atop the more than $300 billion of taxpayer money already poured into those two financial institutions and hundreds of others.

But if hundreds of billions of dollars of new investment is needed to shore up those banks, and perhaps their competitors, what do taxpayers get in return? And how do the risks escalate as government’s role expands from a few bailouts to control over a vast portion of the financial sector of the world’s largest economy?

The Obama administration is making only glancing references to those questions. In an interview Sunday on “This Week” on ABC, the House speaker, Nancy Pelosi, alluded to internal debate when she was asked whether nationalization, or partial nationalization, of the largest banks was a good idea.

“Well, whatever you want to call it,” said Ms. Pelosi, Democrat of California. “If we are strengthening them, then the American people should get some of the upside of that strengthening. Some people call that nationalization. ( I AGREE )

“I’m not talking about total ownership( I AM ),” she quickly cautioned — stopping herself by posing a question: “Would we have ever thought we would see the day when we’d be using that terminology? ‘Nationalization of the banks?’ ”

So far, President Obama’s top aides have steered clear of the word entirely, and they are still actively discussing other alternatives, including creating a “bad bank” that would nationalize the worst nonperforming loans by taking them off the hands of financial institutions without actually taking ownership of the banks. Others talk of de facto nationalization( PROBABLY OUR DESTINATION. ), in which the government owns a sizeable chunk of the banks but not a majority, with all that connotes.

That has already happened; taxpayers are now the biggest shareholders in Bank of America, with about 6 percent of the stock, and in Citigroup, with 7.8 percent. But the government’s influence is far larger than those numbers suggest, because it has guaranteed( THE KEY CONCEPT ) to absorb the losses of some of the two banks’ most toxic assets, a figure that could run into the hundreds of billions of dollars.

Many believe this form of hybrid ownership — part government, part private, with the responsibilities of ownership unclear — will not prove workable( I'VE SAID THAT SINCE SPETEMBER. ).

“The case for full nationalization is far stronger now than it was a few months ago,” said Adam S. Posen, the deputy director of the Peterson Institute for International Economics. “If you don’t own the majority, you don’t get to fire the management, to wipe out the shareholders, to declare that you are just going to take the losses and start over. It’s the mistake the Japanese made in the ’90s.”( YES SIR )

“I would guess that sometime in the next few weeks, President Obama and Tim Geithner,” he said, referring to the nominee for Treasury secretary, “will have to come out and say, ‘It’s much worse than we thought,’ and just bite the bullet.” ( IF ONLY )

So far the Obama administration has signaled that it is trying to avoid that day, and members of its economic team — among them Mr. Geithner and the president’s top economic adviser, Lawrence H. Summers — made the case during the Asian financial crisis in the 1990s that governments make lousy bank managers.

Indeed, the risks of nationalization they warned about then apply equally to the United States now. The first is that nationalization can prove contagious( OVERBLOWN. ). If the Obama administration took over Bank of America and Citigroup, two of the largest banks in the United States, private investors could decide to flee from the likes of JPMorgan Chase and Wells Fargo, or other major banks, fearing they could be next.( THEY NEED TO CHECK THE BOOKS. THAT'S WHAT GOOD INVESTORS DO. )

Moreover, Mr. Obama’s advisers say they are acutely aware that if the government is perceived as running the banks, the administration would come under enormous political pressure to halt foreclosures or lend money to ailing projects in cities or states with powerful constituencies, which could imperil the effort to steer the banks away from the cliff.( AND IF THEY DON'T, THESE PRESSURES GO AWAY? )

“The nightmare scenarios are endless( FEAR AND AVERSION TO RISK IN GOVERNMENT ),” one of the administration’s senior officials said.

The argument in favor of nationalization, even a brief nationalization of a few months or years, is straightforward: It might be the only way to pull America’s largest financial institutions out of the downward spiral that makes it enormously difficult to raise the capital they need to keep operating.( THAT'S MY POINT )

Right now, many banks are reluctant to write off their bad debts, and absorb huge losses, unless they can first raise enough capital to cushion the blow. But they cannot attract that capital without first purging their balance sheets of the toxic assets. Japan’s experience proved the dangers of that downward swirl; the economy stagnated, new lending ground to a halt and the country’s diplomatic clout shrank with its balance sheets.( VERY BAD )

Nationalization could pull the banks out of that dive, at least temporarily, as the government injected capital, hired new managers and ordered a restart to lending. But some Republicans who bit their tongues when President George W. Bush ordered huge interventions in the market would charge that Mr. Obama was steering America toward socialism( PLEASE. THE REAL FEAR IS NATIONALISM OR TOTALITARIANISM, WHICH WILL ENSUE IF WE KEEP PISSING ON THE MIDDLE AND LOWER CLASSES. ).

Nationalization, said Charles Geisst, a financial historian at Manhattan College “is just not a term in the American vocabulary.”( NEITHER IS "WELFARE STATE", BUT THAT'S WHAT WE HAVE. )

“We think of it,” he continued, “as something foreigners do to us, not something we do.”

It is also something foreigners do to themselves: the British have recently taken a majority stake in the Royal Bank of Scotland.

Some of Mr. Obama’s advisers have asked who the government would get to run the banks. Many of the most experienced executives are tainted by the decisions they made during the age of excess. And how would the government attract the best talent if it demanded that they take minimal pay — a political reality in the current environment( YOU CAN'T FIND A SINGLE PATRIOT? WE ARE IN BAD SHAPE. )?

Another option is for the government to buy the banks’ most toxic assets either through a giant fund, or, more likely, a federally supported bad bank designed to buy up troubled investments. But in that case, taxpayers might well be the losers: They would have all of the banks’ worst assets and none of their performing loans. And unless a deal is worked out to take a larger share of the banks whose bad loans are shuffled off to the government, the taxpayers would not have the chance to benefit by selling the shares back to private investors.( A MORASS )

Moreover, cleaning up the banks’ bad assets, without extracting a heavy price for the bank managers, shareholders and their lenders, is exactly what Mr. Summers and Mr. Geithner warned against during the Asian financial crisis.( UM, YES. BUT IT FEELS SO AWFULLY GOOD TO LECTURE PEOPLE. )

“We told the Asians that they had to be willing to let banks and companies fail,” said Jeffrey Garten, a professor at the Yale School of Management and a top official in the Clinton administration. “We warned that there was great moral hazard if governments just bailed them out.”

“And now,” he said, “we are doing the polar opposite of our advice.”(THAT'S OUR SYSTEM )

Who knew that our financial system was based on government guarantees to intervene in case of a financial crisis? Why the Investor Class, of course. Are they socialists too? They surely do seem to be still pulling the strings. Money well spent on their part. They bought insurance from the government, and some people didn't even see it happen.

"but it seems to be the best of many bad solutions"

Andrew Ross Sorkin in the NY Times:

"Dealbook:Obama’s Bailout Challenge

By ANDREW ROSS SORKIN

Another week, another bailout.

Governments in several countries are suddenly scrambling to deliver a second round of financial support to their teetering banking systems, after a first wave handed out at the height of the financial crisis failed miserably in its mission of getting credit flowing again( TRUE ).

Britain on Monday set the stage for a full takeover of its banking system. And now, Barack Obama is trying to figure out how to shore up this nation’s banking industry as its crisis snowballs.

Mr. Obama is going to have one heck of a first day on the job. Already, his aides have a bevy of ideas to sift through, ranging from having government buy banks’ troubled assets, to creating a “bad bank” to soak them up.( YIKES )

And it doesn’t stop there. Others say he should follow the model of Sweden and flat-out nationalize the American banking system( NOT THE ENTIRE SYSTEM. COME ON. ). Or he should inject more money into the banks and force them to lend it( THEY'RE SO GOOD AT IT. ). Another view says he should take a page from Henry M. Paulson Jr., the Treasury secretary, and try to “ring fence” the entire system with the equivalent of government insurance for banks.

Lawrence H. Summers, Mr. Obama’s chief economic adviser, hinted Sunday that he’d been developing a new plan, and seemed to suggest he was leaning toward finding a way to press banks to lend more money. “The focus isn’t going to be on the needs of banks,” he said. “It’s going to be on the needs of the economy for credit.”

Prime Minister Gordon Brown made similar noises on Monday, when he outlined a new £100 billion plan in which the government wrests a promise from banks to raise lending in exchange for having the taxpayer limit the banks’ losses from troubled assets.

“That will be legally binding,” Mr. Brown declared.

But let’s stop for a moment. This has been a popular — and populist — view that has emerged over recent months: those greedy bankers are hoarding our tax dollars instead of lending the money the way they were supposed to do. And it needs to stop.

This view, however, may be misplaced. As Citigroup and Bank of America have sadly demonstrated, if they had lent the money they were given last fall as part of the Treasury Department’s $700 billion bailout plan, they would be in even more trouble than they are now. And we, the taxpayers, would be even worse off.

Why? Because the government bought preferred shares with its first round of capital injections, banks, whose capital cushions have already thinned drastically, must keep the capital on their books if they are eventually to repay the loans.( THAT'S TRUE )

Yet if the banks directly lent the money being pumped into them, many could go bankrupt, requiring the government to step in again( YEP ). At the end of the day, as Mr. Obama and others have acknowledged, the nation must have a viable financial system.

Jamie Dimon, the chief executive of JPMorgan Chase, whose bank received TARP funds, took the issue seriously last week on a conference call with investors. “There have been a lot of questions out there on whether banks are making loans,” he said. “We are making loans all the time, but we are trying to follow the intent and spirit of TARP, which is to help the economy of the United States recover and make sure we’re financing people.”

Mr. Dimon, however, represents just one bank, and it may be the only bulge bracket bank in the nation that is healthy.

Which leads us to the much-heralded idea of following Sweden’s model of nationalizing our banking system. This approach worked quite well for the Swedes in 1992, when their banking industry was teetering much the way ours is now after a real estate bubble and lax lending led to a realization that the banking system was insolvent.

The Swedes spent $11.7 billion at the time, taking huge stakes in their banks. It took years, but eventually, they sold these stakes successfully. And while the gamble at the time was huge — the bill was about 4 percent of its gross domestic product — some observers say Sweden has since been whole. So intriguing was the idea, the Swedes sent a delegation to Washington in September to talk about their experience.

But the Swedish model, as attractive as it appears at first blush, would be a challenge to pull off here in the United States. Aside from the fact that America isn’t about widespread nationalization( JUST WIDESPREAD AND FOOLISH BAILOUTS ), the biggest problem with the Swedish model is that when it is applied here, it costs more — much more.( DID YOU HEAR THAT IT WORKED? )

America has already spent $1.5 trillion trying to solve our problem. To pull off a response similar to Sweden’s, we’d probably have to double, if not triple, that number. The chances we’d recover the money are even slimmer, given how much time it will take a larger economy like ours to come back from such a severe recession.( AND BUYING TOXIC ASSETS? )

More important, the values of our financial garbage — subprime mortgages, C.D.O.’s and derivatives — may eventually prove ethereal. Sweden’s banks had at least backed real tangible assets.

With options narrowing, Mr. Obama is also being pressed to consider the Paulson “ring fence” plan, adopted by Mr. Brown of Britain on Monday. And while it may work there, it would be difficult to make it work here in a systemwide way. So far, it’s been used in an ad hoc manner, customized for each bank.

So we’ve been left with a plan pushed by Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation, that calls for the government to buy up toxic assets from the banks, similar to the original plan for the TARP money.

But that plan was abandoned for all the right reasons: it would mean government would either have to buy the assets at inflated prices from banks — and therefore lose even more money on them — or risk forcing such massive write-downs that the banks would be insolvent all over again.( THAT'S IT )

I know what you’re saying: it’s easy to to knock down others’ ideas — what’s your idea?

Well, how about just following the current system of injecting money into banks to recapitalize them when they need it and “ring-fencing” bad assets when we can? It may not be popular, and it may take a while to work, but it’s one of the few viable alternatives. Perhaps we’ll have to pony up even more money — and maybe we should take an even bigger slice of equity — but it seems to be the best of many bad solutions."

Not quite.

"Given how messy all of these alternatives are, why not simply go down the nationalization route?"

The enormously talented Felix Salmon posts:

"Why Nationalization is the Best Alternative

Kevin Drum is a bit like Joe Nocera: he's reluctant to nationalize, but he doesn't really say why.

It's wise to be wary of nationalization. It should be a last resort( FIRST ), and I've gotten a sense recently that a lot of people are talking about it awfully casually( FOR 4 MONTHS ). Still, it's true that there are some benefits to nationalization, and one of them is that it allows us to avoid the problem of valuing and buying up toxic assets from troubled banks( BINGO! ). If the government owns the whole bank, then the bad stuff can be easily hived off without any kind of valuation at all, and then left to sit for a while before it's sold off -- which is what the Swedes did.
If we have to nationalize, then we have to nationalize. But we should understand the precedents before we do, and go ahead only if we have to.

The only argument I can find in here is an argument in favor of nationalization, not against it. Why should nationalization only be a last resort?( AMEN )

Let's work from an ex hypothesi assumption that a certain bank -- let's call it Citigroup -- is insolvent. This is not an unreasonable assumption, given what happened to the likes of Lehman Brothers and Washington Mutual. But I don't want to get into the details of Citi's balance sheet here: I want to ask what we should do if we've already determined that its assets, many of which fall into the "toxic" category, are significantly smaller than its liabilities.

Now the red-blooded American way of dealing with insolvent companies is bankruptcy: either Chapter 11, where the company continues as a going concern, or some kind of liquidation. For a bank, Chapter 11 is pretty much impossible, since you're not going to find anybody to provide debtor-in-possession financing to keep it going. Except the government. And if the government is in possession, then, hey, you've just nationalized the bank.( TRUE )

As for liquidation, that's not an option, because Citigroup is too big to fail. Dumping Citi's trillions of dollars of assets onto the market in a fire sale would depress asset prices worldwide so much that we'd enter a global depression, not just one in the US. ( TRUE. THE CALLING RUN WOULD PICK UP SPEED. )

So what about the bad-bank option? The government buys Citi's toxic assets, taking them off Citi's balance sheet, and leaving behind a healthy bank. Sounds good -- except remember that, ex hypothesi, Citi is insolvent. If the government buys the toxic assets for what they're worth, then that doesn't help, since the amount of money that Citi gets in return isn't enough to pay off the loans that Citi essentially took out against those assets. In housing parlance, Citi's underwater on its recourse loan, and when you're underwater on a recourse loan, selling the house at its market price doesn't make you any less insolvent.

So maybe the government deliberately overpays for the toxic waste( WHICH IS WHAT WILL HAPPEN )? That's a recipe for opacity, and it's very hard to systematize. If you're willing to pay 150% of market prices for Citi's bad assets, shouldn't you do that for everybody else's, too? Even perfectly healthy banks which don't need the money? Or do you just decide that Citi, because it's too big to fail, is going to get a big handout which no one else qualifies for? If you do make that determination, why not just go the whole hog and write a check to the bank outright, and put it straight into Tier 1 equity? Oh, wait, you can't do that, because that's called buying equity, and if you spent that much money on Citi's equity, you'd end up with a majority stake in the bank -- which is nationalization. ( TRUE )

Essentially, any government purchase of toxic assets can be split into two components: the market price, and a subsidy. If the subsidy is greater than half the market capitalization of the bank, and the government doesn't end up controlling the bank, then there's something very fishy going on indeed.( TRUE )

It's worth bearing in mind here the first TARP proposal, which envisaged the government buying up bad assets at some kind of long-term value price which was greater than the distressed market price. That never happened, the bad assets stayed on the banks' balance sheets -- and then, in the fourth quarter, we saw some absolutely monster write-downs from those loans' end-September marks, including $15 billion at Merrill Lynch alone. You still think that the end-September marks were distressed bargain-basement prices?( THAT'S BEEN MY POINT )

Then there's the insurance proposal -- which is cropping up now in the UK after being rolled out in an ad hoc fashion with Citi and BofA here in the US. Robert Peston explains how it works:

Our biggest banks would identify their bad loans and foolish investments. And they would then pay a fee to a new state-backed insurer to protect themselves from losses over a certain level on these stinky assets.
But the banks would retain these bad assets on their balance sheets. They would not be transferred to a new toxic bank. We as taxpayers wouldn't own the stinky loans - though we would be liable for losses on them over a certain level.

This has all the same problems of the create-a-bad-bank idea: the government still has to come up with a price (a/k/a expected default rate) for the bad assets, and there will still be a huge implicit subsidy, in many cases greater than the bank's market capitalization, for any institution which takes the government up on its offer. After all, the mark-to-market value of the insurer is certain to be massively negative, otherwise Warren Buffett would have set up something like this already on a for-profit basis.( TRUE )

Finally, the government could take the Irish approach, and target the banks' liabilities rather than their assets. Keep the assets on the banks' balance sheets, and simply guarantee all of their unsecured debts. After all, there's a government guarantee on a lot of the unsecured debt already, and there has been for years: it's called the FDIC deposit guarantee.( TRUE )

This is basically a massive bailout for all the banks' bondholders, who thought they were buying risky leveraged single-A bank debt, and who will suddenly find it backed by the full faith and credit of the US government. At this point, it doesn't matter if a bank is insolvent, because it can roll over its debt indefinitely, since that debt has a government guarantee. Indeed, it should be quite happy to lever up as much as it's allowed, and spend its cheap new funds on all manner of risky assets, since that gives shareholders the best chance of making lots of money and recovering some of the billions of dollars that they have lost. It's akin to taking a man with a large debt, pointing him in the direction of a casino, and telling him he has unlimited credit to try and pay that debt off.( YIKES )

The best way for the government to avoid the obvious outcome in such a situation is for the government to take over and run the bank: nationalization. Since the government has an interest in protecting its own liabilities, rather than maximizing shareholder value, the chances of crazy gambles will be minimized. In any case, since the government is taking virtually unlimited downside, it should by rights have all the upside as well -- i.e., ownership.( TRUE )

Given how messy all of these alternatives are, why not simply go down the nationalization route? It's transparent and easy to understand( I'VE SAID THIS FROM THE BEGINNING. ): if a bank is insolvent (and the FDIC is good at making those determinations), then simply nationalize it. That's what the Swedes did, and that's what we should do too.

So I'm interested in what Kevin means when he talks about a situation where "we have to nationalize". Does he mean any situation where a too-big-to-fail bank is insolvent? Or are there further criteria he has in mind?"

Well played! However, I believe that Drum will go for nationlization.

should the government be in the business of declaring that it knows better than the market what assets are worth?

Paul Krugman with a post saying what I've been saying:

"Wall Street Voodoo

By PAUL KRUGMAN

Old-fashioned voodoo economics — the belief in tax-cut magic — has been banished from civilized discourse. The supply-side cult has shrunk to the point that it contains only cranks, charlatans, and Republicans.

But recent news reports suggest that many influential people, including Federal Reserve officials, bank regulators, and, possibly, members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking.

To explain the issue, let me describe the position of a hypothetical bank that I’ll call Gothamgroup, or Gotham for short.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.( YES )

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope that shareholders will be rescued by a government bailout( YES ).

Why would the government bail Gotham out? Because it plays a central role in the financial system. When Lehman was allowed to fail, financial markets froze, and for a few weeks the world economy teetered on the edge of collapse( YEP ). Since we don’t want a repeat performance, Gotham has to be kept functioning. But how can that be done?

Well, the government could simply give Gotham a couple of hundred billion dollars, enough to make it solvent again. But this would, of course, be a huge gift to Gotham’s current shareholders — and it would also encourage excessive risk-taking in the future( WE NEED ONEROUS CONDITIONS ). Still, the possibility of such a gift is what’s now supporting Gotham’s stock price.

A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.( THAT'S MY PLAN )

The current buzz suggests, however, that policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward a compromise( HYBRID ) approach: moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” that would resemble the Resolution Trust Corporation, but without seizing the banks first.( A BANK OF CRAP )

Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, recently tried to describe how this would work: “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?( IT'S A NON-ANSWER )

In my example, Gothamgroup is insolvent because the alleged $400 billion of toxic waste on its books is actually worth only $200 billion. The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.( I AGREE )

Now, maybe private buyers aren’t willing to pay what toxic waste is really worth: “We don’t have really any rational pricing right now for some of these asset categories,” Ms. Bair says. But should the government be in the business of declaring that it knows better than the market what assets are worth( THAT'S MY POINT )? And is it really likely that paying “fair value,” whatever that means, would be enough to make Gotham solvent again( THAT'S IT )?

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets.( YES. AND IT WILL BE A DISASTER WHEN DISCOVERED. )

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. The truth is that Gothamgroup and its sister institutions are already wards of the state, utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover( THE ANSWER ). Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job. "

This has been my position since October.

"it’s mainly based on a false analogy."

Paul Krugman on the Bank Of Crap ( Aggregator, Bad, Toxic, Bank):

"More on the bad bank

OK, I’ve been doing more homework on the “bad” or “aggregator” bank idea that seems to be gaining ground. And here’s what I think: it’s mainly based on a false analogy.( TRUE. I HAVE A BAD FEELING IT'S ALL THOSE RTC ALUMNI HORNING IN ON THE ACTION. )

What people are thinking about, it’s pretty clear, is the Resolution Trust Corporation, which cleaned up the savings and loan mess. That’s a good role model, as far as it goes. But the creation of the RTC did not rescue the S&Ls. The S&Ls were rescued by (1) having FSLIC seize them, cleaning out the stockholders (2) having FSLIC pay down enough debt to make them viable (3) reselling them to new investors. The RTC’s takeover of the bad assets was just a way for taxpayers to reclaim some of the cost of recapitalizing the banks.( TRUE )

What’s being contemplated now, if Sheila Bair’s interview is any indication, is the creation of an RTC-like entity without the rest of the process. The “bad bank” will pay “fair value”, whatever that is( THAT'S THE PROBLEM ), for the assets. But how does that help the situation?

It looks as if we’re back to the idea that toxic waste is really, truly worth much more than anyone is willing to pay for it — and that if only we get the price “right”, the banks will turn out to be solvent after all. In other words, we’re still in Super-SIV territory, the belief that fancy financial engineering can create value out of nothing.

Color me skeptical. I hope the buzz is wrong, and that something more substantive is being planned. Otherwise, we’re looking at Hankie Pankie II: Paulson may be gone, but officials are still determined to believe in financial magic."

I believe that we can't do anything but overpay for these assets. Someday, when that is discovered, a lot of people are going to discover that our system is not being run in their interest. I hope that I'm dead by then.

"to stem the remorseless contraction of credit that's caused our awful recession.

Peston on BBC:

"A bank insurer, not a toxic bank

• Robert Peston
• 17 Jan 09, 12:04 PM

I don't know why the Government hasn't knocked on the head the idea that it's working on the creation of a bad or toxic bank that would buy our biggest banks' dodgy loans and investments.

What I expect it to announce on Monday (although the timetable could slip a day or so) is the creation of the mother-of-all bank insurance schemes.( GOVERNMENT MUST STEP IN AND GUARANTEE EVERYTHING IN A CALLING RUN. )

By the way, the Treasury is also considering making an offer to Lloyds/HBOS and RBS to convert the expensive preference shares they've sold to the Government into ordinary shares.( GOOD )

If this happens, I would expect RBS to say yes and Lloyds to say no. And the conversion would see the state's holding in Royal Bank rising from 57.9 per cent to around 70 per cent, or a good step nearer full nationalisation( GOOD ) (see below for more on this).

But back to this insurance scheme to give banks and their investors a bit more certainty( A GUARANTEE ) about the losses they would face as the recession undermines the ability of many borrowers to repay their debts.

Our biggest banks would identify their bad( CORRECT ) loans and foolish( CORRECT ) investments. And they would then pay a fee to a new state-backed insurer to protect themselves from losses over a certain level on these stinky assets. ( A PROPOSAL PUT FORWARD IN THE US AS WELL. )

But the banks would retain these bad assets on their balance sheets. They would not be transferred to a new toxic bank. We as taxpayers wouldn't own the stinky loans - though we would be liable for losses on them over a certain level.( TRUE )

Why the urgency of doing this?

Well in just a few weeks we'll see results for 2008 from our biggest banks. As I've already pointed out, Royal Bank of Scotland and HBOS will announce unprecedented, horrible losses.

And the HBOS losses would represent a massive drain on its new owner, Lloyds TSB.

There's a fear that unless the Government has developed some kind of safety net for them by then( A FULL GUARANTEE ), there could be an alarming loss of confidence in the banking system of the sort we witnessed in September and October.( A CALLING RUN )

So next week we'll get the announcement that just such a safety net, in the form of the insurance scheme for toxic loans, is in the process of being designed and built.

In a way, it can be seen as a way of getting capital into RBS and Lloyds/HBOS in particular without fully nationalising them.( THAT'S IT )

That said, the scheme will be open to all( IT HAS TO BE TO STOP THE CALLING RUN ) our very biggest banks. So Barclays too could insure away future losses on certain of its loans and investments if that suited it - although on Friday night it insisted that it had made stonking profits of well over £5.3bn in 2008.

However I don't expect a long and detailed statement on the institutional mechanism by which we as taxpayers will pick up part of the bill for the longest banking blow-out in history.

Nor do I expect, as this stage, the Government to put a number on the likely cost to all of us as taxpayers of putting a floor under banks' losses - although the potential liability would run to tens of billions.( TRUE )

Of course it's entirely possible( TRUE ) that if the new state insurer values the assets properly( THIS IS THE REAL PROBLEM ), taxpayers could end up over the years of the scheme with a profit.

But it seems unlikely that this will be a very popular policy. Readers of this blog have repeatedly asked why we as taxpayers should bail out the banks for the consequences of their greed and recklessness( BECAUSE THE CALLING RUN HAS LED TO A PROACTIVITY RUN ). The question I'm always asked is whatever happened to the old-fashioned idea that we should pay for our mistakes?( NATIONALIZING THEM WOULD DO THIS.)

For those working around the clock this weekend at the Treasury, in Downing Street, at the Bank of England and at the Financial Services Authority, the priority is to restore the strength of the banking and financial systems, to stem the remorseless( MANY PEOPLE ACTUALLY ADVOCATE LETTING THIS GO ON! ) contraction of credit( A CALLING RUN, WHERE CAPITAL MUST BE HOARDED FOR CALLS. ) that's caused our awful recession.

In that context, the Treasury and UK Financial Investments (the institution created by the Treasury to manage its investments in banks) have been preparing to make an offer to Lloyds/HBOS and Royal Bank, to convert £9bn of their preference shares (owned by the Treasury) into ordinary shares.

The reason for doing this would be to remove from them the heavy financial burden of paying the 12 per cent dividend of the preference shares.

In the case of RBS for example, the dividend represents an annual cash outflow of £600m and for Lloyds/HBOS the outflow is £480m.

In theory, if the two banks didn't have to pay this dividend they could lend £27bn more every year (because under FSA guidelines, if the £1080m of dividends were retained by the banks as equity capital, the banks would be able to lend a multiple of that core Tier 1 capital).

My strong sense is that RBS would love to convert the prefs, which it regards as costly debt, into ordinary shares - even though that would see it owned 70 per cent or so by the state.

However Lloyds TSB is less keen, because it's 43.4 per cent owned by the public sector and doesn't want to see state-ownership rising above 50 per cent, which would be the result of converting the prefs.

It will be interesting to see whether Lloyds' shareholders would agree that its worth paying out £480m of cash each year to taxpayers to prevent that creeping nationalisation of the bank.

Anyway, as readers of this blog know, there'll be plenty of other initiatives announced next week by the Treasury, most of which can be seen as deploying taxpayers' resources to encourage lending.( THE ONLY WAY )

One of these will be an extension of the timetable for Northern Rock, the fully nationalised mortgage bank, to repay what it's borrowed from the Bank of England and the Treasury. This would put less pressure on the Rock to shrink the amount that it is prepared to lend.

Which at a time when the problem for the economy is a shortage of credit sounds a bit like an outbreak of common sense at the Treasury."

Sorry Bob, this is the only way. Frankly, nationalization would be better. I'm surprised that you don't see that.