(James Saft is a Reuters columnist. The opinions expressed are his own)

So it can be done after all.

Britain is poised to take tough steps to break up the large banks it rescued, setting it in stark contrast to the United States, which seems set on a policy of shoring up the unfair advantages it grants its too-big-to-fail banks while regulating around the edges.

It is quite a change for Britain, which has a sorry history of self-serving self-regulation in financial services combined with limp and outgunned official control.

Chancellor of the Exchequer Alistair Darling on Sunday told the BBC that Lloyds, RBS and Northern Rock would be partly broken up and assets sold to new entrants into the banking market. Large existing competitors such as HSBC are expected to be blocked from making bids for the assets.

Britain took over Northern Rock after a run on the bank and its rescue of Lloyds and RBS left it with stakes of 43 and 70 percent, respectively.

It is worth noting that if anything Britain is more dependent on its financial services sector than the United States.

Could it be that Britain has determined that a level playing field, strong competition and a lower risk of a crisis might actually make it more competitive internationally? I certainly think so.

It will without doubt improve the situation for the small businesses and individuals that can’t access international capital markets and depend on the banks for access to credit and other financial services.

Before we get all excited and expect the United States to follow suit with Citibank and Bank of America, it is important to recall that Britain’s Labour government is more or less on its death bed and faces an election in 2010 which the bookies and almost everyone else think it is highly unlikely to win.

There is also the matter of the European Union, which has a say over subsidies such as the ones Britain has showered on the banks. RBS said on Monday that it may be forced by the EU to sell more assets than it had planned. Lloyds is also seen likely to raise additional new capital to allow it to stay outside of an asset insurance scheme Britain is running for the banks and which would involve the government taking yet more equity in the participants.

OH WHAT A CONTRAST

The fact remains that Britain and the EU are saying that more competition is needed and taking steps to ensure that the banks which ended up needing state care are broken up. This must have an impact on how other big banks are ultimately treated, even if they did not receive the same level of direct state aid.

The equity buffer that is being required is also remarkable; the banks should end up with core tier one equity of about 10 percent, four times what they were expected to hold before the crisis.

Contrast all of this with the hopefully named Financial Stability Improvement Act of 2009, now wending its way through Congress. As Harvard Business School professor David Moss points out, as currently drafted this bill won’t even allow the systemically important banks it is designed to control be named, a real Monty Python-esque touch.

Think about it: we won’t even be allowed to know the identities of the firms we are potentially on the hook for. Moss points out that this neatly side-steps the idea of taxing too-whatever-to-fail status as a means of encouraging the behemoths to sell up and avoid the costs. The costs remain with the taxpayer, or potentially with a group of big firms after the fact.

The argument the U.S. administration is making, more or less, is that our complex global economy somehow demands that we have complex huge banks. If we don’t allow huge banks to persist, we’ll choke off growth. If we think we can go back to mom and pop banking, we are simply kidding ourselves. And anyway, if the U.S. doesn’t allow it, foreign banks will just scoop up the cream. With Britain and the European Union taking strong steps, that argument is losing traction. And as for complexity, well I’d have to say that the record of complexity in banking is mixed, to be kind, as far as the deal it gives to taxpayers and consumers of banking services. It would be one thing to argue for huge economies of scale for plain vanilla banking processes like clearing, but it is hard to see why that needs to be combined with derivatives and trading.

It would be nice to think the winds are blowing west across the Atlantic, but this is not usually the case.

(Editing by James Dalgleish)

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

– James Saft is a Reuters columnist. The opinions expressed are his own –

Nationalization of weak banks in Britain and the United States may be preferable to current plans for insurance and soft “bad banks” schemes which risk being swamped by future losses as assets, especially real estate, continue to crater.

An insurance program, getting banks to identify their riskiest assets to the government which will insure them for a fee, is one of the main planks of a UK plan to bail out banks unveiled this week.

Both Citigroup and Bank of America have already received loss protection arrangements from the government. The betting is now that the United States will opt for some sort of a “bad bank” aggregator which will buy up doubtful assets from banks, with the emphasis on keeping as many as possible operating as publicly traded entities which, once shorn of their bad debts, would be viable and would lend.

Both plans keep banks in private hands, which is desirable, and insurance especially is attractive because it has a relatively low upfront cost. But both, and especially insurance, run a real risk of being too small and, by definition, only ridding the banks of assets that are bad now leaving them to founder on new bad loans later.

Commercial and residential real estate in both countries continues to head south at an alarming rate, with falls of as much as 20 percent or more possible in 2009. Those falls won’t be stopped by current lending programs; it is an ongoing crash that could probably be stopped only by some sort of economy-wide debt writedown which is very unlikely.

That means that we could find ourselves in six or nine months in exactly the same situation, but with banks crippled by a new wave of defaults and with the non-financial economy in a much worse state.

In other words, in order to work a bad bank plan must take into state control the weakest banks and probably needs to err on the side of taking the doubtful down along with the basket cases.

“They should probably nationalize now, but not blanket nationalization,” said George Magnus, senior economic adviser to UBS.

“It is by far the cleaner option, take on all the assets and take on all the liabilities and if you find out that in six months time commercial real estate, for example, has dropped 20 percent it is far less of a shock. You don’t have to treat it as a private vehicle which has to be viable.

“Sell the good bits recapitalized back to the market and you can have viable banks far more quickly.”

DEFINING FAILURE

Consultancy Capital Economics is predicting that British house prices will fall another 20 percent in 2009 and that land values contract by 70 percent peak to trough. British commercial property fell 27 percent last year and analysts in December were forecasting an another 16 percent fall this year. Goldman Sachs economist Jan Hatzius believes the U.S. Case-Shiller 20 City index will fall another 20-25 percent by the third quarter of 2010.

Nationalization is not a good outcome; it is failure defined in a word. And nationalizing banks raises the problem of re-privatizing. Who will want to buy banks from a government with a recent track record of what some will inevitably term confiscation? But few would commit capital to banking now, given that governments have been unable to explain how they will treat capital in the banking system.

If banks are to be taken into state control, there needs to be a process to deal with the rights of shareholders; any bank that stays in state control needs to be run at arm’s length; and the period it stays in state control should be as short as possible.

Easy to say, tough to do and no doubt nationalization will have its disasters.

Bank shares have fallen at an appalling rate on both sides of the Atlantic, with several UK banks trading as if they are in danger of being taken into state control. Royal Bank of Scotland, in which the government already has a 70 percent stake, has lost almost 80 percent of its value in January, while Barclays and Lloyds Plc have fallen precipitously. In the United States, Citigroup has more than halved in value in the month despite equity infusions from the government and an insurance wrapper on some of its assets.

But here is where things differ markedly between the United States and Britain. Britain may well need to do more for its banking system than the U.S. and sadly is less well placed to carry it off without nasty side effects.

The dollar is the world’s reserve currency, allowing the United States more leeway in financing its liabilities, and U.S. banks are smaller as compared to their economy. We’ve already seen sterling falling sharply and you can expect further falls as risk is transferred from the private sector to the state.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click here. –