Substantial minority ownership, yes. Outright nationalization, no.
As U.S. authorities unveiled key details yesterday of how they'll acquire stakes in troubled institutions, Federal Reserve Board chief Ben Bernanke insisted Washington has no plans to seize the country's largest banks or wipe out common shareholders.
"Nationalization, to my mind, is when the government seizes the bank, zeroes out the shareholders, and begins to manage and run [the]bank, and we don't plan anything like that," Mr. Bernanke assured members of the House of Representatives financial services committee. "I think that this debate over nationalization kind of misses the point."
Mr. Bernanke did leave the door open to acquiring sizeable chunks of several of the country's largest banks, including beleaguered Citigroup Inc. The Treasury department is in talks to acquire up to 40 per cent of Citigroup.
"It may be the case that the government will have a substantial minority share in Citi or other banks," Mr. Bernanke told the committee. He said regulators are aiming at close supervision, not micromanagement.
"It will not be a case of giving the money and going away," Mr. Bernanke added.
Speaking to reporters, President Barack Obama went a step further. He said the government has an obligation to taxpayers to keep a very close eye on the banks that receive government cash.
"Financial institutions that pose serious risks, systemic risks, to our market should be subject to serious oversight by the government," Mr. Obama told reporters at the White House, where he outlined a broad outline of a plan to reform financial regulation.
"When the Federal Reserve steps in as a lender of last resort, which it's had to do repeatedly since this financial crisis began, it's providing an insurance policy underwritten by the American taxpayer."
The Treasury department disclosed key details of its plan to buy preferred shares, convertible into common equity. Under the deal, banks would have the power to force the conversion, at a 10 per cent discount to their price that prevailed on Feb. 9. The preferred shares would enjoy a 9 per cent dividend.
The shares would automatically be converted into common stock if they weren't redeemed or converted within seven years.
Any bank participating in the program would also be subject to restrictions on dividend payments, share repurchases and acquisitions. Dividends would be capped at 1 cent per quarter for as long as the government owned preferred or common stock.
The catch for the government is that common shares offer considerably less protection if a bank fails. The value of common stock is typically wiped out.
The government has already bought roughly $200-billion (U.S.) worth of preferred stock in 400 financial institutions. Banks would now have the choice of converting those to common stock in order to shore up capital and reduce dividend payments.
On the other hand, taxpayers would stand to reap the rewards if stocks rebound.
The Treasury Department also provided details of how it will apply a new stress test designed to determine which banks have enough capital to weather a pretty nasty recession. The results won't be ready until the end of April. The test is being given to the 19 largest U.S. banks, which have assets of at least $100-billion.
The stress test will determine how the banks would fair under two scenarios, including a baseline forecast as well as a much deeper recession.
The "baseline" scenario envisions that the economy would shrink 2 per cent this year, unemployment would reach 8.4 per cent and home prices would fall another 14 per cent. The more negative scenario assumes a drop in gross domestic product of 3.3 per cent, an 8.9 per cent jobless rate and a 22 per cent slump in home prices.
The tests are designed to figure out if the big banks can absorb future losses and still continue lending. If they can't handle the two forecast scenarios, Treasury will give the bank six months to raise additional capital. Bank must raise the money privately or the government will trigger an automatic sale of the convertible preferred shares.
The U.S. economy officially tumbled into recession at the end of 2007. GDP fell 3.8 per cent in the final three months of last year, and most economists expect an even larger decline in the current quarter.
The unemployment rate in January was 7.6 per cent, the highest in more than 16 years.