Bank regulators pledge more help, reject nationalization

Share prices of Citi and Bank of America have plunged in recent weeks, as investors view them as the two most likely candidates for government takeover.

WASHINGTON (MCT) - Amid growing concerns that the U.S. government may be forced to take over large parts of the banking system, five federal regulators issued a joint statement Monday announcing the creation of a special lifeline to keep troubled banks afloat, but they rejected outright nationalization.

The Treasury Department, the Federal Reserve and three other bank regulators said the government would make available to banks, on a temporary basis, capital needed to buffer against bigger-than-anticipated losses.

The money comes from the Capital Assistance Program, a bank rescue plan that the Obama administration announced Feb. 10, which spooked the markets because it lacked details.

"This additional capital does not imply a new capital standard and it is not expected to be maintained on an ongoing basis," the regulators said in their statement, in wording designed to signal that this wasn't bank nationalization.

The regulators closed their statement with even more explicit language that tried to calm markets' fears that the government of the world's largest economy might be forced to take over private banks:

"Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands."

The statement followed news reports over the weekend that Citigroup is negotiating with regulators to have the U.S. government take a stake, as high as 40 percent, in the storied bank. If so, it would be the third government intervention in Citigroup since October.

As was the case in the earlier rollout of financial rescue plans, the Obama administration struggled Monday to explain its new program. News reports were all over the map because of confusion over what the new program did or didn't do, and many financial-industry executives hadn't been informed about the latest effort.

Financial markets should have seen the announcement as positive, but the administration's lack of a coherent message to explain what it meant and how it works sent the Dow Jones Industrial Average almost 100 points into negative territory by midday.

Although Monday's statement most affects Citigroup and Bank of America, the two financial giants that are under the most pressure from investors, the effort is designed more broadly to restore faith in the financial sector. The statement noted that banks today are adequately capitalized.

"This is really a cushion against the economy deteriorating further," said Scott Talbott, the senior vice president for government affairs at the Financial Services Roundtable, a trade association for financial institutions.

Nevertheless, Monday's announcement amounts to a semi-nationalization of the banking system because the government will be providing taxpayers' money with conditions to shore up balance sheets amid the deepening economic downturn. The injection of additional capital _ beyond the roughly $300 billion already put into banks through last October's Wall Street bailout _ would come through what are being called "mandatory convertible preferred shares."

In last year's Wall Street bailout, banks that received taxpayer money gave the government preferred shares of bank stock. Those banks can keep that arrangement or turn those stocks into these new "convertible preferred shares," which could be converted to common stock if banks need to raise capital. All new government money would come with "convertible preferred shares."

By converting to common stock, banks could pay shareholders lower dividends, but in exchange for these lower costs, the government would become a larger shareholder in the banks and could gain effective controlling interest in the banks _ thus backdoor nationalization.

"This may have a stabilizing effect. It can be customized to each institution's particular financial condition," Talbott said.

Share prices of Citi and Bank of America have plunged in recent weeks, as investors view them as the two most likely candidates for government takeover.

The Obama administration's bank-rescue plan includes so-called stress tests, wherein regulators would simulate much deeper economic deterioration and gauge whether the banks had adequate capital reserves to prevent collapse.

These stress tests are thought to have started already, although Monday's statement said that they would formally begin Wednesday. That's one day before the Federal Deposit Insurance Corp. and the Office of Thrift Supervision, two of the regulators that signed the new statement, are expected to place many more financial institutions on their lists of "problem" institutions that need to be watched closely.

The fifth federal regulator that signed Monday's statement was the Office of the Comptroller of the Currency.

Since October, the federal government and private investors have put hundreds of billions of dollars into banks in hopes that they'll stabilize and keep lending. As the economy deteriorates, however, the portfolio of existing loans grows ever worse, and a wide range of economic thinkers have concluded recently that nationalizing the banks may be inevitable.

The regulators sought Monday to send a message that there will soon be a mechanism in place to ensure that banks will have capital to lend even if the economy goes further south.

This wouldn't be a front-door nationalization, in which the government seized control, but would allow for scenarios in which the government effectively has nationalized a bank by taking such a large stakeholder position in it.

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Critics of bank rescue efforts argue that providing more money to the banks in today's environment is throwing good money after bad. They reject the idea that the government can't seize a big bank for fear that it would damage the rest of the financial sector.

"Are you kidding? Have you looked at where the indices are or where the relevant stocks are trading? The markets are way ahead of policymakers. Only cutting off the head of the beast would calm markets at this point," Joshua Rosner, the managing director of the New York investment-research firm Graham Fisher & Co., wrote in a research note. "The faster we demonstrate a willingness to kill the terminally wounded the sooner the viable will begin to trade based on fundamentals and not faulty assumptions."