Oct. 1 (Bloomberg) -- Maybe we should call it Red Monday. Sept. 29 turned out to be the day that big chunks of Europe's financial industry got taken over by the state.

The U.K. government stepped in to rescue mortgage lender Bradford & Bingley Plc. In Brussels, Fortis received a lifeline from the governments of Belgium, the Netherlands and Luxembourg as investor confidence in the bank evaporated. Iceland bought a 75 percent stake in Glitnir Bank hf.

Don't expect them to be the last. Before this crisis has played out, much of the financial system may be in state hands.

The trouble is, the cure is almost as bad as the disease. The state-run banks will be just as risky as the private ones we have now. They will spend money on just as many stupid things. In a few years, we'll be thinking about taking them private again.

It looks like bankers will have to get used to working for the government. The nationalization of Bradford & Bingley and the earlier takeover of Northern Rock Plc mean that two of the biggest lenders in the U.K. are now part of the public sector. The country that led the privatization charge in the 1980s is now taking the world in the opposite direction. The Fortis bailout will give the Belgian government 49 percent of the domestic banking unit: It will be state-owned in every meaningful sense.

Yesterday, the Irish government moved to guarantee the deposits in its banks. Lenders such as Bank of Ireland Plc and Anglo Irish Bank Corp. Plc seem just as vulnerable as U.K. mortgage banks, and the share prices have been savaged in the last few weeks. These companies, too, are now effectively state- controlled.

Spanish Banks

Meanwhile, no one wants to look too closely at the big Spanish banks. Spain has had a steep decline in real-estate prices, so there must be big losses in the system somewhere. Like a hardened gambler at the casino table, Banco Santander SA keeps doubling its bets, taking on more and more of the failing British finance industry. Perhaps it is making itself too big to be allowed to fail -- not a bad strategy under the circumstances.

Even Germany, which managed to skip the property bubble enjoyed by much of the world, has banks in trouble. Hypo Real Estate Holding AG, the country's second-biggest commercial- property lender, received an emergency loan guarantee yesterday.

No one knows where this crisis will end. Whether it's complete or partial nationalization of the banking system, the state will be the dominant force for years to come.

In time, we'll come to resent that. Here's why.

No Constraints

First, without shareholders, there won't be any effective pressure to perform. We think that means the banks will take fewer risks. The truth is that without shareholders, the new state-owned banks will take just as many chances as the old bonus-driven ones did. After all, they won't need to worry about profits anymore. And with the governments behind them, they won't be constrained by a lack of capital. So why not expand rapidly? After all, that's how you make yourself more important.

Next, the banks will be exposed to constant political interference. With governments as their main shareholders, there will be nothing to stop politicians meddling in financial decisions. They won't be foreclosing on dud loans -- and certainly not if they are in sensitive constituencies. They won't cut staff when they need to. They will hand out loans to ``national champions'' that probably don't deserve them. That will end in more losses, not fewer.

Don't expect to see much in the way of innovation in the next 10 years. Once they are run by the state, there won't be any genuine competition forcing banks to offer new products. In time, that will start to hurt. Europe has an aging population that will need more financial innovation to meet this challenge. But it won't be getting any new thinking from state-dominated banks.

Different Ways

Lastly, with the banks run by the government, access to money will be determined more by connections than by commercial astuteness. It is a myth to imagine that state-owned banks will allocate capital more efficiently than shareholder-owned ones. They will still blow it, but in a different way.

Let's not forget that the record of state-run banks is grim. Credit Lyonnais SA was one example when it was owned by the French government. Amongst other terrible decisions, it ended up owning the MGM movie studio. Don't be surprised if Fortis executives are running around Hollywood in a few years.

A bailout may well be needed now because there are too many risks involved in letting banks go bust. Yet putting them into government ownership fixes today's crisis at the cost of creating a new set of problems. Bankers like nothing better than to spend other people's money, and they have just been handed a bottomless pit of the stuff. The results won't be pretty.

(Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net.

Last Updated: September 30, 2008 19:01 EDT