Crisis Q&A: What “Bank Nationalization” Means For You

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January 21, 2009, 3:22 pm

It only takes one good bank-stock rout to turn Americans into big believers in government control.

Yesterday’s precipitous plummet in shares of Bank of America, PNC Financial, State Street and other financials may have done the job; the controversy of the day centers around “bank nationalization,” or giving our government the license to run U.S. banks.

Deal Journal provides a primer on what bank nationalization means to the average taxpayer.

What does bank nationalization mean?

Bank nationalization, in the most practical form, means giving the U.S. government the power to control banks. That could mean taking control of the public shares, to the power to pick and install new management and boards of directors, and set corporate strategy. The shocks of the credit crisis last fall spurred lawmakers to semi-nationalize the banking sector; nearly 314 institutions have already signed over some of their shares and other securities to the Treasury in return for $350 billion in government aid.

The government has taken a dramatic intermediate step toward nationalization by taking effective control of American International Group, Fannie Mae and Freddie Mac, but leaving some of their shares on the public markets and their management in private hands. Proponents of U.S. bank nationalization now envision a program by which the government would take over only the largest banks, for a short period of time, in order to loosen the ties on lending. The government may also inject more capital into the banks if necessary, but the belief is that the presence of a government overlord acts more as an implied guarantee to soothe customers and prevent assets from going out the door.

Why nationalize banks?

In Western countries, bank nationalization is largely used as an emergency method to prop up banks during tough times, which includes ??a lending to small and medium-sized businesses and restructuring burdensome loans to consumers. It can help big banks avoid immediate insolvency. Proponents of bank nationalization argue that current government solutions to the financial crisis have failed, in part because lawmakers have committed as much as $8.5 trillion to support programs without seeing a significant difference in the health of banks, public confidence, or an expansion of lending. Many major banks have accepted government funds but have hoarded them to protect against a rainy day or another steep drop in the value of their loans. The government has already provided $40 billion in cash to Bank of America, for instance, and added another $118 billion in support for the bank’s troubled debts. At Tuesday’s closing price, the entire market value of Bank of America was about $25.5 billion, meaning that the cash and guarantees from the Treasury are worth about six times as much as Bank of America itself.

What is this costing me?

Duke University finance professor Campbell Harvey estimates that every $150 billion government grant is equivalent to a $1000 contribution from every working or employable American taxpayer. Given the $700 billion Troubled Asset Relief Program alone, every working American is providing $4000 to the bailout from his or her own bank account. That would more than double to $8000 if the entire $825 billion Obama stimulus package is thrown in. For many homeowners, that would be several months worth of mortgage payments.

Has nationalization ever worked before?

Most experts believe in nationalization only as a temporary measure, partly because of its mixed history of success. In general, banks are under government control for two reasons: either because an administration or regime maintains near-complete control of all businesses, as in China, Russia North Africa and South America, or because there is a severe economic crisis that impels government action, as in the case of Sweden and Indonesia in the 1990s and the United Kingdom in the cases of Northern Rock, Bradford & Bingley and the Royal Bank of Scotland in the fall of 2008. France has nationalized its banking sector, privatized it again by selling it into private hands, and now may be in the process of another wave of nationalization. In the U.S., very few banks have been fully nationalized, although there have been many cases where the government seized a troubled bank to sell its assets or wind down its operations. That was the case during the savings and loan crisis of the 1990s, when the government took over hundreds of banks for one to two years, installed new chief executives and board members, and steered the process of disposing of their assets. It was also the case with IndyMac, which was seized in July and recently sold to a group of private equity firms. Such seizures have been fruitful in returning money to the government, but they do not count as full nationalizations since their purpose is to stop an imminent failure. In addition, seizures tend to wipe out value as consumers abandon a troubled bank, although the impact is far less than it would be in a total bank failure.

How would nationalization affect the other government rescue efforts?

While the government would have to move some of its chess pieces on the board, few experts believe that nationalization would impact existing government guarantee and aid programs, including deposit guarantees from the Federal Deposit Insurance Corp. The FDIC is, however, well-capitalized because it has direct access to Treasury funds.

What are the disadvantages of bank nationalization?

In the United States, the biggest problem for the government would be the sheer impracticality and expense of taking over all 8,000 banks — or even the 314 institutions that described themselves as “banks” in order to receive government funds. The U.S. government would have, at most, the ability to take over only a handful of the most important institutions. As a result, nationalization would not solve the pressing problem of potential bank failures, particularly among small banks. Consumers who have deposits in such banks would still be dependent on the Federal Deposit Insurance Corp. to return their money during a failure. If larger institutions fail, they can also create damaging shockwaves throughout the markets and cause hundreds of millions of dollars in assets to disappear into thin air, as in the case of Lehman Brothers. In addition, there is significant disagreement over the purpose of bank nationalization.

Will bank nationalization end the credit crisis?

Some experts believe it would allow the government to end the credit crisis by taking control over — and opening– the spigot for lending. Opponents, however, argue that the real problem with U.S. banks is their vast supply of undesirable, toxic assets; nationalization would do nothing to solve that problem unless the government also created a megafund or “bad bank” to absorb the troubled assets and remove them from the banks’ books. Opponents of bank nationalization also fear that consumers might run away from banks that don’t have the advantage of explicit government control, which would leave the government playing favorites and the industry as a whole in a shambles.

What does nationalization mean for shareholders?

In all previous bank nationalizations shareholders were wiped out. Preferred shares have been also wiped out by even the intermediate nationalizations such as those of AIG, Fannie Mae and Freddie Mac, and are also not likely to survive a nationalization.

http://blogs.wsj.com/deals/2009/01/21/cris...-means-for-you/

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Please just start the business of total control of our whole lives and get it over with.

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Fears rise that U.S. Will seize big banks

Janet Whitman, Financial Post Published: Saturday, January 24, 2009

Is Bank of America Corp. about to become Bank of American Taxpayers?

That's the fate many investors fear is awaiting the banking giant and other troubled lenders across the country as the credit crunch shows little signs of abating despite the billions pumped into the sector by the U. S. government over the past few months.

Growing speculation the U. S. government could end up nationalizing some banks -- a move that would completely wipe out shareholder stakes -- has sent bank stocks tumbling, with Bank of America and its more deeply troubled rival, Citigroup Inc., sliding deep into the single digits.

Most banking industry observers aren't predicting a broad-based nationalization of U. S. banks -- the cost would be prohibitive and not every bank is in terrible shape. But observers aren't ruling out the possibility that some banks could end up going that route.

"Most banks are going to power their way through the current crisis," said Bert Ely, a Virginia-based industry consultant. "Obviously, the biggest question mark is over Citi ... Bank of America is a lesser concern."

Even with the deepening woes in the industry, most analysts agree that Barack Obama, the new U. S. President, and his economic advisors would be loathe to nationalize any bank and would employ the measure only as a last resort.

"I don't think a Democrat would like to be tarred with that brush [of having] created an army of bureaucrats running banks," said Manny Weintraub, a former managing director of investment-advisory firm Neuberger Berman and founder of money-management firm Integre Advisors. "It's better just to dilute the hell out of shareholders by buying stakes in the banks. Then the government can have all of the fun without any of the political liability."

Thanks to US$350-billion worth of capital injections by the U. S. government over the past few months, taxpayers already hold large stakes in more than 300 banks, including the No. 1 shareholder stakes in Bank of America and Citigroup.

"That's a partial nationalization as it is," said Alex Pollock, a resident fellow at the American Enterprise Institute in Washington. "A full nationalization is a highly unattractive vision and I hope we don't get there. One thing a government does not do well at is running a business."

Proponents of bank nationalization point to Sweden's takeover of about five big banks back in the early 1990s as a possible model for the United States to follow to try to dig the country out of the ongoing credit crisis.

But not everyone sees that effort as a model for success here.

"It took Sweden a while to recover to the point where banks were lending again," said Thomas Cooley, dean of New York University's Stern School of Business. "Here, banks are much bigger and the economy is much bigger. Even the British, who are much less averse to that sort of thing, are desperately trying to avoid owning all of [Royal Bank of Scotland], even though they own most of it now. It's not a business you want the government in."

For now, Mr. Obama and his economic advisors are scrambling to come up with a viable plan to help instill investor confidence in a banking system that's struggling to dig itself our from under mounds of losses and bad bets created by years of reckless lending.

One of the most talked about alternatives is the creation of a government-sponsored "bad" bank, which would buy up all of the toxic assets clogging up the balance sheets of banks.

That option of buying up bad assets, which essentially is the same plan Henry Paulson, the U. S. Treasury Secretary, proposed in October when he got approval from U. S. Congress for the US$700-billion Wall Street bailout, could end up costing between US$2-trillion and US$3-trillion.

Whatever bank rescue strategy the Obama administration decides to roll out in the next few weeks, the plan must be a decisive one so that investor confidence in the banking sector can be restored.

Otherwise, industry observers said, the odds of banks getting nationalized will get a lot stronger.

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