The road less traveled

Is it better to be bailed out by your own government or someone else's? A choice between two evils, perhaps, since no self-respecting capitalist should ever expect any kind of bailout. But if you must go cap in hand to the state, bolstered by that sense of entitlement to which the leaders of the world's largest banks now presume, wouldn't you turn first to the government that has regulated your activities in the past and expect it to exercise further control in future? U.K. lenders Royal Bank of Scotland Group plc and Lloyds TSB Group plc chose that familiar path, as did several European banks, which now face government interference in their lending policies as well as limits on dividends and bonuses.

Alternatively, you might turn, as Barclays plc CEO John Varley has done, to the leader of a wealthy Middle Eastern statelet. He happens to be sitting on a large sum of money, which he wishes to invest in financial assets. He can move quickly and without fuss. His state is not a democracy, and he need turn to no taxpayer, shareholder or voter for approval. His government is unlikely to impose restrictions on your behavior to appease voters, though it may one day make other demands.

British banks have been divided on taking government money. What has sorted the homebodies from the adventurers has been neither philosophy nor principle, but necessity.

It was need that drove Royal Bank of Scotland to accept the British government's aid. Overextended and overleveraged after its ill-advised investment in the €72 billion ($92 billion) takeover of ABN Amro Holdings NV and its heavy lending to private equity, the bank has issued a profit warning and taken serious credit markdowns. Royal Bank will place £15 billion ($24 billion) of ordinary shares at 65.5 pence apiece in an issue underwritten by the state. It is also selling the government £5 billion of preference shares with a fixed rate of interest of 12% -- and will likely end up under majority government control.

Meanwhile Lloyds, having been encouraged by the government to buy its weaker rival HBOS plc, now finds itself low on equity. It has similarly turned to the state for help in underwriting an issue of ordinary shares and buying preference shares. The government could acquire up to 43% of the combined group.

But Barclays has resisted the government's advances, believing itself strong enough to bolster its Tier 1 capital ratio without taxpayers' help. It turned instead to Sheikh Mansour bin Zayed Al Nahyan, a member of the Abu Dhabi royal family, for £3.5 billion of his personal fortune and to Qatar Investment Authority chairman Sheikh Hamad bin Jassim bin Jabr Al-Thani, who will invest £2.8 billion. A further £1.5 billion of convertible notes will be offered to other institutional investors, but by the time the associated warrants and convertible shares have converted, Barclays' Middle Eastern backers could hold up to 32% of the bank -- and at a hefty discount to the bank's share price when the deal was announced.

Both Royal Bank and Lloyds TSB will pay dearly for taxpayers' backing both in the cost of their money and the government's insistence they pay no dividends until its own preference shares have been redeemed. Following Barclays' example, Lloyds TSB is already reported to be looking to sell stakes to sovereign wealth funds and U.K. insurers so that the bank can redeem the government's preference shares early and start paying dividends again. But Barclays will pay more for its apparent freedom. The investors will receive hefty fees and commissions for taking the bait at a heavily discounted price, as well as interest on the convertible notes and an admittedly tax-deductible coupon of 14% on other instruments. Last but not least, Barclays has no real idea what the new shareholders may eventually want in return for their money. If you visit their tents or their palaces, Middle Eastern people are famously hospitable. But there is no such thing as a free lunch.