by Lily S

Created on: January 29, 2009

Bank shares have been falling like stones in this crisis, with shares of companies like Barclays going from over 7 pounds in 2007 to less than 50 pence in 2009 (a 93% drop). At the root of these share price falls is the fear investors have that the companies are making such huge losses and have so much toxic debt on their books that only the taxpayer can save them.

But if the taxpayer takes control of the banks, they usually want a stake in the bank, and will frequently nationalise without compensation of the shareholders. After all, the shareholders egged on the banks to make their risky deals, and the risk of holding shares is that you can lose everything. Hence the reason bank shares are being dumped by panicky investors.

During some nationalisations, the government does provide some compensation to shareholders at the market rate at the time of taking the company into state ownership - but this is usually when the government is taking on a perfectly viable business for strategic reasons. But when a nationalisation means that a government is taking on massive risk and has to pump billions into a company (something no private investor would do), it makes no sense to pay out money to shareholders too (especially as the companies would have gone bust without government intervention and in that scenario the shareholders would have got nothing anyway).

Thus those who are investing in bank shares at the moment are taking on a massive gamble. If the banks they are investing in manage to turn themselves round, clear their toxic debt, repay the loans the government has provided and buy out the government preference shares, there are handsome gains to be had. But it is quite as likely that it will take years to sort out the banks, and thus years before you realise your investment. And there is a very real risk that the bank you are investing in worsens in outlook which might need the government to make a full scale nationalisation.

If you are an existing shareholder, it might be best to write off your shares in your mind - they may come good, they may not, but after the falls in price, it's really too late to sell. If you are a new investor, only invest a small amount, and regard it as a pure gamble, and recognise you can lose your money. Try to choose a bank that has prudent lending practices and that doesn't have an investment banking arm (the source of much toxic debt).

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