Brother, Can You Spare a Trillion?

As big banks on government life support — particularly Bank of America and Citigroup — continue to struggle amid rising fears that they are mortally wounded “zombie banks,” a growing chorus of industry leaders are calling for the nationalization of insolvent lending institutions.

Last week, in an interview with the Financial Times, former Federal Reserve chairman Alan Greenspan warned that the TARP money was inadequate and that nationalization may be necessary “in order to facilitate a swift and orderly restructuring” of banks, adding that “to stabilize the American banking system and restore normal lending, additional TARP funds will be required.”

Speaking to George Stephanopoulos on ABC, conservative Republican U.S. Sen. Lindsey Graham of South Carolina, said last week: “This idea of nationalizing banks is not comfortable, but I think we have so many toxic assets spread throughout the banking and financial community throughout the world that we’re going to have to do something that no one ever envisioned a year ago and no one likes. But to me, banking and housing are the root cause of this problem.… I would not take off the table the idea of nationalizing the banks.”

Playing down fears that the government would nationalize American financial institutions, Federal Reserve Chairman Ben Bernanke said this week: “We don’t need majority ownership to work with the banks.”

Over the past year, 39 banks, mostly small regional lenders, have failed — the fastest rate since the 1980s Savings & Loan crisis, according to the FDIC. Nearly 252 banks are on the “problem list” and being watched closely by the FDIC. This week, the Obama administration began taking a hard look at the financial condition of the country’s 20 biggest banks, giving them “stress tests” to judge whether they can hold up even if the downturn worsens.

And last week Uncle Sam all but nationalized Citigroup, a vast financial colossus which is at the heart of the U.S. banking meltdown. Is Bank of America next?

Keeping dead banks walking, however, is bad policy. The stock prices of Citigroup and Bank of America recently both hit a 17-year low, trading below $5.00 a share. The losses from toxic loans are so massive at both of these banks that they are effectively insolvent. Citigroup and BofA’s stock values are entirely based on the hope that shareholders will be rescued by another Uncle Sam bailout. And the Wall Street Journal reported that the Obama administration is in talks to expand the government’s ownership stake in other struggling lenders.

But is nationalization the way out? Should the Obama administration pump additional billions — maybe trillions — of taxpayer money into insolvent zombie banks?

If the U.S. government starts to nationalize banks, as it did during the 1980s, it should seize the defunct bank’s assets, fire its senior management and wipeout shareholders. Then, it should clean up their balance sheet by transferring the bad assets to a special institution (remember the Resolution Trust Corporation?) and then pay off the banks’ debt to make them solvent and sell the fixed-up bank to new owners.

The sad truth, however, is that the nationalization of zombie banks is just another boulder in an avalanche of asset write downs that will cascade down the economy throughout much of 2009. An overhang of toxic sub-prime-like assets, at least as large as the deteriorating balance sheets of Citigroup and Bank of America, is festering in corporate debt, commercial mortgages, credit cards and other portfolios.

The foreclosure crisis and the recession will end when the market finds a bottom in both the value of homes and the net worth of banks. The sooner we slay the zombies, the faster the market will find the bottom. Artificially keeping zombie banks alive will only prolong the housing recovery and extend the length of the recession.

What are your thoughts? Should the Feds keep pumping billions into failed financial institutions? Is there a smarter way to halt the financial train wreck?