Nationalization. Nobody is sure exactly what the word means, but its mere mention sends shivers up the spine.
On Monday, the Dow fell 250 points after some top legislators said the government might have to nationalize banks, at least temporarily.
On Tuesday and Wednesday, Fed Chairman Ben Bernanke and Treasury Secretary Timothy Geithner tried hard to reassure investors they had no plans to nationalize the banks, but on Friday, the U.S. government moved closer to taking a major stake in Citigroup. After gaining some ground, the Dow still ended the week down 251 points.
"Nationalization is a loaded term for a lot of people. It's seen as the kind of thing that European or more socialist governments do," says Douglas Elliott, a fellow at the Brookings Institution.
But what, exactly, does nationalization mean and what are its pros and cons? Here's are some answers.
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Q:What is nationalization?
A: There is no single definition. In its purest sense, the government would take complete ownership of a bank, including all of its assets and liabilities, and run it day-to-day, the way it operates the U.S. Postal Service. If the company operated at a loss, taxpayers would foot the difference. If the company was liquidated and its assets exceeded its debts, taxpayers would be on the hook.
A government could partially nationalize a bank without taking complete control.
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Many people would consider a bank nationalized if the government owned at least 51 percent of its common stock.
The government could also take effective control of a company without buying any stock, as it has done with Fannie Mae and Freddie Mac, says banking analyst Bert Ely.
The U.S. government has bought preferred stock in the eight largest banks and hundreds of smaller ones under the Troubled Asset Relief Plan. This is generally not considered nationalization because the preferred stock doesn't have voting rights.
On Wednesday, however, the Treasury unveiled a new Capital Assistance Program. Under the plan, large banks that can't pass a "stress test" will have six months to raise additional capital from private investors. If they can't, they must sell the government preferred stock that is convertible into common stock after seven years. The bank could convert the stock or buy it back before seven years. Some people see this as creeping nationalization.
On Friday, Citigroup said it will offer to convert almost $27.5 billion in preferred stock held by investors and up to $25 billion held by the government into common stock. If all shares are exchanged, the government would own 36 percent of the company. The government is already demanding that Citigroup overhaul its board. It's hard not to see this as partial nationalization.
Q:Has the United States ever nationalized a bank?
A: Yes. In 1983, it took over Continental Illinois, at that time the sixth-largest bank. The Federal Deposit Insurance Corp. has also taken over failed banks when it couldn't find a buyer, as it did with IndyMac last year, Elliott says.
Although the FDIC sold IndyMac within a few months, it took the government seven years to wind down its stake in Continental Illinois.
Today's banks in danger of nationalization are many times bigger and more complex
Q:Didn't the government nationalize thrifts in the early 1990s?
A: Yes, but the situation was different from today.
The Resolution Trust Corp. took over failed savings & loan associations with the sole purpose of liquidating them.
"The government was the undertaker. We were burying the dead," says Ely. "Today, we are dealing with institutions that have issues but many pieces are very viable." The government would be more like a vet, "nursing the sick whales back to health."
Q:Why do investors worry about nationalization?
A: If the government took over a bank, its common stockholders would get little or nothing. Although depositors would not lose money, other creditors, such as bondholders, could get hurt if their debt were restructured, as it would be in a bankruptcy.
Even in a partial nationalization, common shareholders would get hurt if the bank issued new shares to the government because their ownership stake would be proportionately less.
Q:What are the other dangers?
A: Taxpayers would probably lose money. There would also be political pressure to pursue social goals such as lending to low-income people.
Money will go "to sectors of the economy that are in trouble or those with the lowest rates of return. The government will direct funds to aid the poor, not to rebuild the nation," writes Richard Bove, a banking analyst with Rochedale Research.
While some see this as a positive, it would probably hurt taxpayers.
Government ownership would also create "a competitive imbalance between banks that are nationalized and those that are not," says Ely. "It becomes a rerun of the Fannie-Freddie problem."
Although Fannie and Freddie were shareholder-owned companies with no explicit government backing, most investors assumed that the government - which set them up - would come to their rescue if times got tough. As a result, they could borrow more money, at lower rates, than other companies.
"They used the implicit guarantee of the government to take much riskier positions than they would have if they were (purely) private enterprises," Elliott says.
It also forced them to serve two masters - politicians who wanted them to increase homeownership and shareholders who wanted them to increase profit.
"This was a big part of Fannie and Freddie's undoing," Elliott says.
Q:Why consider nationalization?
A: To prevent a run on a large bank and the chain reaction that would set off.
"Whether we like the banks or not ... they are central to our whole economy," Elliott says. "They are the main way we get money from savers to businesses, homeowners. If we let the existing banking system fall apart, it will cause immense destruction."
http://www.sfgate.com/business/article/What-really-happens-when-banks-are-nationalized-3169639.php
