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Economy & Business

Beacon-omics 101: Nationalizing troubled U.S. banks - should we be worried?

This article first appeared in the St. Louis Beacon, Feb. 23, 2009 - Speculation that major U.S. banks such as Citigroup and Bank of America could be nationalized has been sending shivers down the economy's already shaky spine.

While the Obama administration has said it does not want to nationalize banks, the concept has been raised by such diverse voices as Sen. Lindsey Graham R-S.C., and Alan Greenspan, former chairman of the Federal Reserve.

Stuart Greenbaum, a business professor at Washington University, explains that the concept of nationalization is anathema in American culture -- on a par with terms such as "socialism." At the same time, he says, the government already had its hand in the nation's banking system, long before the emergency infusion of $350 billion through the Troubled Assets Relief Program (TARP).

"The truth of the matter is that we have, in a sense, nationalized the banks by pieces. The government has already guaranteed their debts. The deposits are guaranteed. And now they've put public money into preferred stock. So the government is even more closely approximating being a shareholder," said Greenbaum, a former dean of the Olin School of Business.

Under new steps announced Monday, some of the government's preferred stock in banks that was acquired in exchange for TARP funds could be converted into common stock. The action, which would reduce dividend payments and ease repayment pressures on the banks, was announced in a joint statement by the Treasury Department, the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, Office of Thrift Supervision.

Greenbaum points out that there is a difference between true nationalization, in which the government would own the banks, and the current reality, which finds the government as a very large -- and possibly controlling -- shareholder. He cited speculation about the conversion of the government's preferred stock in Citigroup.

"If they convert the currently owned stock into common stock, the government could own 40 percent of the equity of the bank. It wouldn't own 100 percent, but 40 percent is enough to control the bank," Greenbaum said. "So the government then has effective control. It has displaced the private owners as the controlling shareholder. Now, it's not nationalization because nationalization wouldn't be 40 percent ownership, it would be 100 percent ownership."

Greenbaum said that using terms such as nationalization and socialism can be counterproductive -- and doesn't further the discussion.

"It is viewed as essentially a bipolar alternative: It's either one or the other, and there's nothing in between," he said.

Greenbaum said the reality is that the federal government is likely to end up as the controlling shareholder in deeply troubled banks because the only other alternative might be receivership, which creates more problems in the financial system.

"In fact, many people believe that one of the tipping points in this financial distress we're in right now was the receivership of Lehman Brothers. So, there isn't a lot of interest in putting them into receivership because of these so-called systemic implications," he said.

Greenbaum said that while the notion of nationalization may be a violation of American cultural precepts, decisions need to be made regarding "impaired institutions."

"There are not many terrifically attractive options here, and these ideological questions and simplistic framing of the issues really do a disservice to the community," he said. "I think people in Washington are groping around for what they feel to be the best, and their decisions are conditioned by some of this ideological ranting and raving."

He points to a comment that Fed Chairman Ben Bernanke reportedly made to colleagues in September during discussions of the emergency financial bailout: "There are no atheists in foxholes and no ideologues in financial crises."

"Ideologues get in the way," Greenbaum said. "You have to think about what train's going to get you to the next station. What's going to work? Everyone becomes a pragmatist. If, indeed, Citigroup is going to come for another $20 billion or $25 billion, it would be folly for the government not to take control. It would be folly to leave it in the hands of the people who managed the decline of the institution. Give them another $25 billion in working capital without exercising controls would be downright irresponsible."

Defined

Nationalization The act of transferring ownership from the private sector to the public sector. Deprivatization often occurs when a government attempts to maintain the stability of its critical infrastructure during periods of economic distress. This can occur in various segments of the economy.

Source: Investopedia.com

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