Bad News Banks

Story Highlights:

• Political talk of nationalizing banks is gaining ground among those who think government bailouts for banks are amounting to little progress.
• The nationalization threat is reflected in bank stocks, which are trading as if nationalization is a foregone conclusion. The vagueness of Treasury Secretary Timothy Geithner's "stress tests" proposal in last Tuesday's speech no doubt added fuel to the fire.
• There's little doubt the US government would do a much worse job managing specific banks than the private sector, but bank nationalization of one or a few wouldn't necessarily make the entire system any worse.
• The banking sector and its stocks will face major challenges for some time. Fortunately, history shows one depressed market sector won't keep the overall market from recovering.

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Politicians are putting their mouth where our money is—and that's bad news for banks. Political talk of nationalizing banks is gaining ground among those who think government bailouts for banks are amounting to no more than. Even ex-Fed head Alan Greenspanfor the idea, claiming temporary government ownership would allow for "swift and orderly" bank restructuring.

This rhetoric demonstrates politicians are still out for banks' blood—and they just might get it. The nationalization threat will undoubtedly keep private capital far, far away from the institutions that need it. Banks needing additional funds have few options other than turning to the government, which could lead to outright government takeovers.

This threat is reflected in bank stocks, which are nationalization is a foregone conclusion. Treasury Secretary Timothy Geithner's "stress test" proposal for banks in last Tuesday's speech no doubt added fuel to the nationalization fire. Since Treasury can devise whatever test it wants and banks that don't pass have little chance of surviving independently, banks' fates remain mired in uncertainty. (Unfortunately, increased uncertainty seems to follow every new Fed or Treasury attempt to improve conditions in this sector.)

There's little doubt the US government would do a much worse job managing these banks than the private sector. In government hands, decisions will likely not be made to produce profits (an essential goal in capitalism), but to serve political interests. Even the Fed and Treasury about nationalizing banks—Fed Chair Ben Bernanke expressed doubts governments can "manage banks for a protracted period," and Geithner echoed these sentiments noting, "Governments are terrible managers of bad assets."

But bank nationalization in certain cases wouldn't necessarily make current problems any worse, and if done right (for example, very clearly defined with set parameters like ), could even make a bad thing as good as it can be for markets to digest and move on. After all, it's clear most investors already expect this outcome.

Still, despite the political tongue-lashings suggesting otherwise, it's important economically to note the banking sector continues to function and bank lending hasn't fallen off a cliff. In fact in some areas, commercial bank lending

Even so, there will be neither reprieve nor end of uncertainty for banks anytime soon, and this sector and its stocks will face major challenges for some time. US markets for the cycle on Thursday—perhaps under the weight of banks' bad news—though double- or even triple-bottoms are at the end of bears. Fortunately, one depressed market sector won't keep the overall market from recovering.