The thumping chorus to drain the toxic assets clogging our banking system drones on as the economy patiently waits for the life-blood of new credit. Many argue that bank nationalization may be our only hope. This is naïve madness.

Early quarterly earnings reports from U.S. banks clearly demonstrate the banking system’s hefty ability to absorb “toxicity” on its own. While there is a natural obsession among analysts and the financial media to dice and denigrate headline-earnings results, core operating margins appear substantively intact.

When the final tallies are in, U.S. banks should still be earning nearly $250 billion annually in operating margin before loan losses and other markdowns. Equally impressive, new bank lending is nothing short of robust. Combined new lending and loan commitments exceeded $500 billion in just one quarter for the first three large banks to report. Put another way, these three extended nearly seven times their TARP capital in the space of just one quarter.

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It is understandable that mistakes were made by the government during the heightened stress, politics, and uncertainty of last September and October. But the truth is that a super-majority of banks that received TARP capital did not need or want it from the outset, and it’s no surprise that they now want to return it. As the earnings reports trickle in, it should be increasingly clear that many banks are quite capable of self-rescue and recovery without government involvement in their capital structures.

And yet the White House and Treasury Department are still discussing the possibility of a forced conversion of the TARP money held by banks from preferred stock to common stock. This in essence will transfer bank voting rights to the government, putting the banks squarely on the road to nationalization. This talk is exceptionally disturbing and irrational. It arbitrarily front-loads all future problems by applying largely opaque loss-prediction formulas to bank balance sheets. And it subverts the re-liquification progress already achieved by the actions of the Federal Reserve, FDIC, and U.S. Treasury.

Nationalization of major banks almost always is a messy, lengthy, and counterproductive process. Ask any emerging market. We tried it once with Continental Illinois — a bank that represented only 2 percent of U.S. banking assets — which required seven costly years to shrink and eventually re-privatize. Bank nationalization will transfer a massive and unnecessary burden onto the taxpayers while steadily depleting lending activity. On a larger scale, a dearth of new private capital and competent management following nationalization could send our banking system back to the 19th century.

The government forces that would move the banks toward nationalization claim that recipients of TARP capital have sharply reduced their lending activity and are still in need of saving. This is a computational mystery that defies the Federal Reserve’s own data. Bank credit in March was up 5 percent compared to a year ago, while bank credit declined only slightly during the first quarter — mostly due to the lower demand associated with collapsing GDP. Factoring in loan pay-downs and losses, I estimate that more than $700 billion in gross new loans were probably made during the first quarter, with commitments even higher.

Members of our financial system are uniformly and repeatedly cast as insolvent zombies. But the truth is that today’s credit shortfall is entirely in secondary and other “non-bank” financial markets. This “shadow banking system” — which includes institutional investors, insurance companies, investment banks, pension funds, monolines, collateralized debt and structured investment pools, and other non-deposit financial entities — has been left bleeding to death in the cold.

The shadow banking system is far larger than our banking system. More than 80 percent of residential mortgages are not made by banks, while more than half of non-mortgage consumer credit is funded by this shadow banking system. And within that system, mortgage, card, and auto credit from securitized investment pools is down $750 billion over the last year. The system is in complete shutdown. And yet the government is focused on plunging its bloated TARP hypodermics into the banks.

Last year’s formulaic TARP capital-blanketing exercise appears to have been unwise and counterproductive. Nevertheless, big banks are now attempting to return this unnecessary capital, and they should be cheered with patriotic fanfare.

More important, recycled TARP capital may well be needed to rebuild our secondary markets. The government-sponsored auctions put together for this purpose have so far attracted barely $7 billion in issuers. The goal is $1 trillion, and another $5 trillion to $6 trillion could be waiting in the wings. And if these auctions continue to fall short, the banks eventually will have to fund some of these loans.

The good news is that Americans are saving again, placing much of their money in bank deposits. But banks ultimately will need new capital to expand their balance sheets into any permanent vacuum left by the secondary markets. And where will this longer-term capital come from? It can best come from private-sector sources, and it will once investors have had an opportunity to observe the banking industry’s continued problem-absorption powers and its increasing ability to fund new credit.

Of course, it doesn’t help that an atmosphere of bank demonization has been polluting public confidence. The air can clear only when government TARP capital exits the banking system. Conversely, if the U.S. government continues to fan the flames of public outcry and force more public capital on the banking industry, public ownership will be ensnared, taxpayer costs will be magnified and solidified, and the capacity for future U.S. credit and capital formation will be diminished.

— Robert B. Albertson is principal and chief strategist for Sandler O’Neill & Partners LP.