The debate rages-to nationalize or not. Early in the week the nationalization crowd seemed to be carrying the day but the cons have fought back. High on their lists of reasons not to go to government ownership is the contention that doing so would scare new investors away from banks and once you start where do you stop. Let me offer some thoughts in rebuttal.

Before I get there, let’s agree to banish the nationalization word from the discussion. It’s emotionally loaded. In the U.S. the protocol isn’t nationalization. The subject institution is deemed to be insolvent, the FDIC steps in as the receiver of the failed bank, transfers it to a new operating corporation which wipes out any pending liabilities or litigation and then proceeds to sell as much as it can of the successor institution and liquidate that which nobody wants to touch with a ten foot pole.

The objectors to receivership seem to me to raise two issues. One, if you start where do you stop. And two, if you do this you will scare equity and debt investors away from the industry.

The “if you start where do you stop” argument is based on the premise that once you start taking over failed banks the unwanted or unsaleable assets will end up in the government’s hands. If I follow their logic, either the government sells them off at fire sale prices or retains them at some sort of impaired value, and thereby establishes a market price to which the rest of the industry must mark. The fallout is that you take more banks down as they have to recognize the present value of those assets. That may be true but may also be a superior solution to simply pretending that a group of banks are viable when the opposite may be true. Price discovery can sometimes be a bitch.

I have made the point before that our experience with the RTC demonstrated that once the bad assets are segregated and sold two things seem to happen. One, the first group of buyers strike exceptionally good deals and two, the follow-on buyers successively bid the prices up. It isn’t a given that the eventual value or new marks are logically the price that the first buyer pays. We may in fact find that market value is higher than illiquid markets have indicated. At least we will have realistic information to use for follow-on decisions but it is not necessarily a given that receivership for a few inevitably means receivership for the many.

The argument that we will scare away investors isn’t supported by history. There is a grand tradition of bank failures in this country and for that matter worldwide. Have investors shunned it as a result. Of course not, they realize that absent bad assets banking is a very lucrative business. Less than twenty years ago a large number of banks were taken into receivership by the FDIC in this country. Did investors say no mas?  They did not. Capital has been readily flowing into banks ever since.

The receivership option is not a new road for either the country of the FDIC. We have been down it before and it did not destroy the industry nor did it deter investment in the industry. What will destroy the investment community’s appetite for bank investment is a policy that fails to quickly recognize asset values and props up insolvent financial institutions. We call that policy TARP right now.