The stock market slumped to a 12-year low last week, partly over fear of a single word: nationalization.
It’s a word Americans are used to hearing from South American republics. Now, it’s being mentioned — prominently — as a potential fate for some of America’s largest banks.
Over the past two weeks, free-market conservatives such as former Federal Reserve Chairman Alan Greenspan and Sen. Lindsey Graham, R-S.C., have said some giant banks may have to be nationalized temporarily.
The nation’s second-biggest bank, Citigroup, negotiated its own partial nationalization last week. The deal would convert up to $25 billion of the government’s $45 billion capital stake in the bank from preferred stock to common stock.
The U.S. Treasury would have up to a 36 percent of the equity voting power at troubled Citigroup. The government’s new clout in bank management showed in Citigroup’s decision to reform its board, putting independent directors in a majority.
For the record, both the administration of President Barack Obama and the Federal Reserve indicate that they don’t want to nationalize banks. The question concerns whether they will have much choice.
Citigroup lost $27 billion last year, threatening its survival without a government bailout.
Other giant banks may be headed in the same direction as the economy sinks.
The FDIC reported last week that America’s banks lost $26 billion in the last quarter of 2008, the biggest banking bust since 1990. More than two-thirds of banks made money, but profits at small and mid-sized banks were outweighed by massive losses at big banks.
"They’ll do this kind of deal with other companies," said Joe Stieven of Stieven Capital Advisors, a longtime St. Louis bank analyst. "I think this is good for the U.S., but in the short term it could be bad for common shareholders."
Other analysts see Bank of America as the next most likely to need a government investment as it struggles with bad loans and the consequences of acquiring big, sick companies.
"Bank of America was a rock of strength until it took on Countrywide Mortgage and Merrill Lynch," said Stuart Greenbaum, former dean and professor emeritus at Washington University’s business school.
LOCAL IMPACT
The issue could have an impact on St. Louis. Citigroup has no branches here, but it owns CitiMortgage, which employs about 3,500 people in O’Fallon. Many St. Louisans also have mortgages, credit cards or loans through the bank.
Bank of America has 61 branches in our region and is a major lender here. It holds 14 percent of the St. Louis area’s deposits, a market share second only to U.S. Bank.
Other big players in the St. Louis market will be subject to the government’s new "stress test," in which it will judge large banks’ ability to survive a deeper recession. They include U.S. Bank, PNC Financial (purchaser of ailing National City Bank) and Regions Bank.
All are headquartered elsewhere but have branch networks in St. Louis. Together, they and Bank of America hold 40 percent of the St. Louis deposit market.
Nationalization means government control of failing companies. That’s already happened in the case of insurer AIG and mortgage giants Fannie Mae and Freddie Mac. In the case of banks, nationalization would take place as the government injected capital into the banks in exchange for stock, until the government owned a controlling interest.
In theory, the government would recapitalize the banks, then sell its shares back to private ownership as the economy recovered. If things go well, the government might recover its money or even make a profit.
Stieven thinks the Citigroup deal is structured well, because it allows the government to force changes at the company while leaving management in private hands.
But some wonder what might happen as time goes on: Would Uncle Sam change lending policies? Will pressure from Congress influence who gets loans?
"A money-center bank in government hands would become a conduit for politicized lending and grants disguised as loans," wrote Gerald O’Driscoll, a fellow at the libertarian Cato Institute and a former vice president at the Federal Reserve Bank of Dallas.
Greenbaum thinks the government may use its newfound control for another goal: breaking up the biggest financial institutions fast payday loans. The biggest have strayed far beyond the business of lending money and now have fingers in financial markets around the globe. They are now so complex that their own managers can’t comprehend them, he says.
"If a bank is too big to fail, maybe it’s too big to succeed," he says.
FDIC TAKEOVERS
In one way, bank nationalization is nothing new. The FDIC has been doing it every Friday as it seizes banks that are insolvent or nearly so. It pays off the depositors, in part with federal money, and sells the branches. Shareholders are wiped out.
It did just that last month with Corn Belt Bank of Pittsfield, Ill. The FDIC took over on a Friday, and the branches reopened four days later as part of Carlinville National Bank.
In fact, the FDIC prefers to act before banks go broke, by forcing the weaklings into the arms of healthy banks. PNC’s takeover of ailing National City last October was such a shotgun marriage.
Economists say those actions have a big advantage: They’re a clean break. The losses are written off, and the surviving banks go on lending.
In the savings and loan crisis of the late 1980s, the government seized hundreds of failed S&Ls, placed their assets in a government corporation and sold them off over time. The cost of those seizures, which didn’t threaten the country’s banking system, cost taxpayers more than $120 billion.
The problem comes with banks that are too big to sell, and too big to fail.
Giants such as Citigroup, with more than $2 trillion in assets, are deeply entwined in a web of interlocking obligations to institutions around the world. Citigroup’s failure could set off a financial panic that might bring even healthy banks to their knees.
If giant banks can’t fail, then what’s to be done with them when they go insolvent? One danger is that they continue as "zombies," the living dead of the financial system.
Even insolvent banks can stagger on for long periods. They’re too sick to lend, but they suck consumer deposits away from healthier banks that would actually use the money to make loans.
"The very existence of large zombie banks would make it more difficult to restart the flow of credit," wrote Douglas Elliott of the Brookings Institution, a Washington think tank.
Economists blame Japan’s "lost decade" of the 1990s partly on the government’s reluctance to fix failing banks.
That brings up the Swedish solution. When Swedish banks began failing in the 1990s, the government took them over and recapitalized them. Then the Swedes sold them back to the private sector.
Obama’s plan, announced last week, would put the biggest banks through stress tests to see how they would cope in a deeper recession. Those deemed weak would be given a chance to raise private capital. If they can’t, the government would step in as the banks weakened, providing capital in exchange for an ownership stake.
The root of the banking crisis lies in the pile of "toxic assets," mainly mortgage securities, weighing down bank balance sheets. If big banks could unload them at reasonable prices, they’d be on the road to recovery.
But no one wants to buy, so it’s hard to put a price on them. And the government is hesitant to become the buyer of last resort: If it paid too much, it would stick the taxpayers with huge losses. If it paid too little, banks would still be weak.
Obama’s solution is to seed a private fund with government capital, hoping to tempt private investors. The fund would then buy toxic assets, with the private investors negotiating the price.
Will the Obama plan work? "It’s a reasonable alternative right now," says Anne Villamil, a professor of economics at the University of Illinois, adding that we’d never been in a mess such as this before.
Greenbaum is more blunt. "It’s a piece of arrogance to think we really know what we’re doing," he said.
jgallagher@post-dispatch.com | 314-340-8390
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