Uncle Sam takes a greater role in US banking

The federal government could own more than one-third of Citigroup.

By , Staff writer

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    Troubled bank: In what Fed Chairman Ben Bernanke calls a "partnership," the federal government will exchange $25 billion in bailout money for up to a 36 percent equity in Citibank. This branch is in downtown Boston.
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Federal involvement in the US banking industry has moved into a new phase.

In a deal announced Friday, the giant bank Citigroup agreed to a plan in which the government intends to take as much as a 36 percent ownership stake in the ailing bank.

Call it partial nationalization if you want. Or, since many Americans don’t like the word nationalization, Federal Reserve Chairman Ben Bernanke floated “partnership” as an alternative word this week.

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The goal of the Treasury and other bank regulators is try to prop up a troubled industry so that it can play its vital role in the economy -- and help to end the current recession.

Whatever word one uses for it, the government’s role has already been widening as it tries to rescue banks that face rising loan losses.

Since September, the Treasury has pumped some $165 billion into eight of the largest banks in the form of preferred stock. But in none of those cases has the federal ownership stake edged toward effective control of the company.

In the Citigroup deal, that is poised to change.

A large chunk of the Treasury’s existing preferred shares would convert into common stock -- making the government stake far larger than any other common shareholder.

Citi is an exceptional case, not the new rule. At many banks, the government will simply be playing the role of a more vigilant regulator. At others, it will be to put in capital as a preferred shareholder. But at some large banks, the Treasury may follow down the road now paved at Citi, becoming a common shareholder.

“The government has pretty much labeled those guys as too big to fail,” says Jaime Peters, a banking analyst at the investment firm Morningstar in Chicago.

To keep them from failing, the Treasury’s planned course under President Obama is to assess how healthy the major banks are, and then inject new capital as necessary. It would come in the form of preferred shares that may be converted to common shares down the road, if needed by the banks themselves.

An alternative course, total nationalization of some big banks, is favored by some economists. But the administration and the Federal Reserve are saying that this should be avoided if at all possible. Citigroup for months has been viewed as the most troubled of the big banks.

Friday’s deal represented the third rescue maneuver by the Treasury, following two capital infusions in recent months.

Here’s how the Citi deal will work: The government will exchange up to $25 billion of its preferred shares in Citi for as much as a 36 percent equity stake. Although the conversion to common stock will dilute current shareholders’ investments, the wider equity base could establish greater confidence that Citi has the reserves in place to guard against further losses.

Common stock is viewed by investors as a stronger form of capital than preferred shares. The deal is contingent on private investors agreeing to a similar swap of preferred for common shares.

In congressional testimony this week, Chairman Bernanke addressed the question of whether the government might end up with more than a 50 percent stake in the common shares of some banks.

He suggested that the distinction between less than majority control and more is not that important. In either case, government regulators have lots of influence over banks. And the government’s goal is to return to a fully private-sector banking system as soon as possible.

But one point he made with sharp clarity: Returning banks to health is vital in order for the economy to stage any real rebound.

“If we’re going to have a strong recovery, it’s got to be on the back of a stabilization of the financial system,” Bernanke said. “It’s basically black and white. If we stabilize the financial system adequately, we'll get a reasonable recovery. It might take some time. If we don’t stabilize the financial system, we’re going to founder for some time.”

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