Banking clarity

The federal government has taken over 17 failing banks and thrifts this year, seizing them at a rate three times faster than last year. At that pace, it will "nationalize" 85 banks by year's end, compared with three -- yes, three -- in 2007. Yet many analysts and investors wonder whether the government should be taking over more financial institutions, particularly a number of "too big to fail" firms that may not have the money to cover their expanding losses. The push for nationalizing big, troubled firms is coming from liberals and conservatives alike, as is the resistance. President Obama, Federal Reserve Chairman Ben S. Bernanke and other top administration officials have spoken out against nationalization, yet their comments haven't provided much reassurance to investors fearful of being wiped out by a federal takeover. That uncertainty is hampering the financial industry's recovery, potentially dragging the government -- and taxpayers -- more deeply into the mess.

The term "nationalization" calls up images of centrally planned economies and intrusive governments, but for banks and thrifts it's simply a streamlined process for resolving a bankruptcy. In 16 of the 17 seizures this year, the feds quickly sold the firm to a larger, healthier institution; the 17th was closed and its depositors reimbursed. Failed banks' shareholders lose their stakes in a takeover, and the banks' bondholders and other debt investors take at least a partial loss. The larger the bank, however, the more difficult it can be for the government to unload it; for example, the Federal Deposit Insurance Corp. had to manage the failed IndyMac Bancorp for eight months before finally selling it to a private equity group.

Another problem posed when giant banks veer toward insolvency is "systemic risk." The banks' depositors are insured up to the limits set by the FDIC, but there are no such guarantees for the investors who bought the banks' bonds or traded in their derivatives. Those investors often include other banks, insurance companies and financial firms around the globe. Forcing them to absorb billions in losses could set off a cascade of write-downs and asset sales that exacerbate the credit crunch. A case in point is the shock wave that hit the financial industry when Lehman Bros. failed, paralyzing the credit markets and sending American International Group into a costly federal receivership.