One of the premises of the bailout bill is that the banking industry must have government help to get back on its feet.

A banking industry expert, Bert Ely, who has a stellar track record in predicting crises and calling false alarms says that the banking industry can handle this mess internally and does not need subsidies.

The comments from Bert come in an interview at Institutional Risk Analytics (the entire newsletter is wide-ranging and very much worth reading), First, IRA’s recap of Ely’s qualifications:

To get some perspective on the evolution of the last remaining large investment banks into commercial banks, we now turn to Bert Ely, one of the leading experts on banking and finance in the Washington policy community. An accountant by training, Ely has specialized in deposit insurance and banking structure issues since 1981. In 1986, he became an early predictor of the S&L crisis and a taxpayer bailout of the FSLIC. In 1991, he was the first person to correctly predict the non crisis in commercial banking. In 1992, he predicted an eventual taxpayer bailout of the Japanese banking system.

Here are the excerpts that relate to whether the banks need government intervention:

The IRA: And if our internal estimates at IRA are correct about the magnitude of the losses facing the industry, then the banks may not have the resources to deal with the problems alone. What then?

Ely: That is of course the trillion dollar question. I have run the numbers looking at the capacity of the industry to pay the tab. Assuming that bank insolvency losses don’t get way out of line, which I don’t think they will, then the industry can handle it. It’s not going to be cheap, but the banks can handle it and clean up their own mess. The losses will feed back through the industry to depositors and borrowers in the form of lower rates on deposits and higher cost of loans….

The IRA: So you oppose the idea of the government putting preferred equity into solvent but troubled banks that cannot raise capital on reasonable terms?

Ely: Yes, it is not necessary, even now. There is absolutely no need for the Treasury to have the authority, as you suggested, to “inject capital into solvent banks that are temporarily unable to raise new capital.” If a bank truly is solvent, it can raise additional capital or sell itself, if its present owners are realistic about what their bank is worth. The reason solvent banks have a problem raising capital, or selling themselves to a stronger bank, is that they set their price too high, as did AIG. As an aside, I am glad to see AIG’s shareholders getting whacked by the warrants associated with the Fed’s taxpayer’s loan to AIG. There is absolutely no need for the taxpayer to subsidize banks so they can stay independent, provided no barriers are erected to prevent new entrants into bank or specific banking markets.

The IRA: Agreed. We were referring to banks that could not be recapitalized or sold. A sale is obviously the first, best choice. So you would let the banks resolve their problems privately. Would you agree with Ernie Patrikis (‘A Change in Bank Control: Interview With Ernest Patrikis’, July 9, 2008′) that the Fed needs to loosen the restrictions on bank ownership in order to facilitate this process?

Ely: I fully agree that restrictions limiting investors from taking significant positions in banks should be lifted. Not only is the belief in separating banking from commerce invalid in an open, competitive economy, but we need to get ruthless investors inside troubled banks to get these banks and their bad assets cleaned up and/or sold. That is what should have happened at AIG, but unfortunately did not.

The IRA: Precisely. We want to see the bad assets remain in private hands, not in a government warehouse for toxic waste. But why then should anyone support Paulson’s proposal to place these toxic assets in the hands of the government? Chairman Frank seems to want to declare the jubilee and engage in mass loan forgiveness in order to ensure his permanent re-election. Maybe we can just all stay home instead of going to work and Barney Frank will just mail everyone a check.

Ely: Look, all of the fallout we are seeing in the markets today is part of clearing the detritus from the last speculative bubble. The housing bubble has to be allowed to collapse in order to clear the markets. We have a very necessary correction process underway. But this process creates a lot of pain and loss. I don’t like that, but we have to clean up the mess and take the pain in order to get the economy back into balance. In collapsing bubbles you have collapsing companies. Japan tried to muddle through and they had a lost decade. I hope we are not going to do that…

The IRA: But that is precisely the point. Why should Washington use taxpayer funds to rescue people who deliberately made bad business decisions?

Ely: This is the question that comes up frequently about Dick Fuld at Lehman and Kerry Killinger at WM. When these guys were contemplating life, did they have any second thoughts, any doubts about these decisions? Did hushed discussions among the top folks in their organizations, with the senior managers and directors, include deliberations such as these or were they too arrogant, too isolated from reality?…

The IRA: How do you see the Paulson plan unfolding? What should the markets expect in the next couple of weeks and months?

Ely: It is likely that Congress will not pass the Paulson bailout legislation this week. However, whenever it is passed, it will be much more complex, and incorporate unwise punitive terms and conditions that will seriously impede the intent of the Paulson plan. Further, I believe the process of pricing the assets purchased under the legislation will be much more complex and contentious than many appreciate at this time, which means that this program will get off to a much slower start than many anticipate, just as the RTC started quite slowly. If the Paulson plan starts slowly, market forces may sweep past the plan. It will be extremely interesting to see how this plan evolves over the next year, particularly given that a new Administration will come to power on January 20.