Two weeks ago I attended the Atlantic Economic Society meetings, where Franklin Allen's presidential address grimly said the most likely scenario to unfold is the nationalization of the banking industry. We've already seen early, incremental signs of course (over the weekend the Dutch injected $10 billion into ING with many strings attached). Today, Financial analyst/journalist Christopher Whalen explains why he is bearish on big banks and bullish on more intervention. After describing the Treasury Department's "voluntary" capital plan and its high hopes:

We regret to say that the Q3 2008 earnings reports from US banks will do little to dissuade markets that more crisis remains ahead. In front of us still are several quarters of old fashioned realized losses in the form of possibly record levels of bank loan charge-offs, so don't hold your breath waiting for US commercial banks to start growing lending exposure anytime soon.

The $125 billion allocated to bank capital infusions by Treasury Secretary Hank Paulson so far is the appetizer and soup course of the meal, in our opinion. Next year comes the main course, when we could see Citigroup (NYSE:C) and JPMorgan (NYSE:JPM) end up under government control if aggregate loan loss rates peak well-above 1990s levels. Click here to see the non-accrual loans of the largest US banks by assets.

Remember, Paulson's tune has changed over the course of the past year from one of "nothing to see here" to "the sky is falling and the Treasury needs to prop it up." He has also famously made false promises (e.g. "bazooka"). How reasonable is it to expect that all is well now? That we won't be asked to hand over just this little bit more power?

An overlooked problem: once Paulson et al. say "everything is going to be okay, we're confident that we got it right this time," now they are accountable for future downturns, at which time they'll say "okay, now we really mean it, just a little more power and we'll get it right this time."

We've seen this before, of course. In fact, it's the broadest cause for the housing bubble to begin with. Once politicians started to take credit for increasing home ownership rates, the political incentive structure was set in place to ruin the housing market. Again Whalen:

The precursors of the Great Subprime Bust of 2008 start in Washington, with members of both political parties feeding at the affordable housing trough and "spreading the wealth" to use the well worn phrase. Indeed so much wealth was spread, like jam scraped over too much bread, that the result is a partially nationalized US banking system and trillions of dollars in realized losses to investors. And this all in the name of "affordable housing."

Thus we wonder if the next evolution of the public debate regarding the banking industry bailout should be to consider not whether more capital must be injected into the largest banks - rising loan loss rates should make this obvious to all by now - but what is to be done with the biggest banks that the Treasury may very well control by the end of 2009. Building bigger, dumber mega banks, we submit, is a bad choice, while redistributing the deposits and assets of the big banks into more numerous, stronger hands makes enormous sense.