Cold comfort

The office conversation segues seamlessly from the trials of Royal Bank of Scotland Group plc to the merits of Barney the Dinosaur; from the British government's apparently open-ended offer to insure the banking sector's toxic assets, to a colleague's attempts to keep a baby occupied. It is hard not to wonder if the issues are in some way related. Maybe if the banks had, all along, kept things childishly simple -- not borrowing short-term to lend long-term, relying on deposits rather than complex financial instruments to fund their lending -- we wouldn't be in this big, adults-only mess we are in today.

Did the bankers believe they were getting AAA-rated collateralized debt obligations when what the touts were selling was really X-rated securitization porn? Do we have to feel sorry for the bankers, who have swapped their addiction to wholesale lending for an infantile dependency on the stern father figure at the Treasury as he slowly, but inexorably, tightens his grip on their capital and drags them screaming and kicking into nationalization? Or is it the government that is being abused by the big, bad bankers, thrust into ever-more abject dependency on their unfulfilled promises?

Does the Chancellor of the Exchequer, Alistair Darling, find his negotiating position weaker by the day, knowing he needs banks to revive the economy, yet forced to refill their glasses with ever greater slugs of taxpayers' money as they sit on their hands and do nothing? Does Ali D have any influence at all over what happens at partly nationalized banks?

There's plenty of playground name-calling to show the government really is too weak to stand up and fight in noble silence, like a man. Prime Minister Gordon Brown tells the banks they have to come clean about their toxic assets. (Otherwise how will we know what we are insuring?) Brown tells RBS its unprecedented £28 billion ($39 billion) loss is the result of irresponsible overseas investments, largely in subprime assets in the U.S. and the disastrous acquisition of ABN Amro Bank NV. Brown claims he is furious that British taxpayers' money is going to pay for losses overseas. But hasn't the British government always promoted foreign investment? Wasn't the government happy to encourage British banks to buy shares in banks in China? Hasn't that always been the quid pro quo for allowing foreign companies to invest here? Sure they can buy our assets, but we make money by buying theirs, too.

The sad truth is, though, that standing up for what is right seems to do more harm than good. Demanding a premium from the banks to help repay taxpayer for a bailout gives the banks an excuse to withhold the lending the government wants to encourage. For instance, forcing nationalized mortgage lender Northern Rock plc to repay the taxpayer ahead of schedule by reducing its loan book led to an increase in foreclosures. It may also have encouraged other banks to believe that mortgage lending was less of a priority for the government than its public statements might suggest. Now Northern Rock has more time to repay, in return for a pledge of increased lending and a boost to the housing market.

Similarly, the government has decided in this second bailout of RBS to convert £5 billion of preference shares, carrying a special dividend, but no voting rights, to ordinary shares. The move increases its stake in the bank to 70% from 58%, but also seems to have signaled to the markets a newly predatory approach to public ownership. Instead of stabilizing the stock, the combination of creeping nationalization at RBS and the bank's own shocking figures sent prices tumbling at other banks as well.

It certainly didn't help matters that the Financial Services Authority, the U.K.'s financial institutions watchdog, lifted its ban on short-selling bank shares just days before the bailout announcement. No doubt the FSA had perfectly sound reasons. The ban had only been partially effective in stabilizing share prices and was widely considered to have squeezed much-needed liquidity from the market.

But the results have been predictable, with billions wiped off the prices of relatively healthy institutions as well as the ailing RBS.

In the end, although the government may throw a tantrum or two, and the banks may continue their naughty lending strike, it is the taxpayer and the banks' shareholders who must continue to foot unlimited bills. No wonder we turn to Barney's friend Baby Bop and her comfort blanket.