US Clears Path to Bank Takeovers
by: Binyamin Appelbaum and David Cho
The Washington Post

Obama’s revised plan for industry aid could result in
nationalization.

The Obama administration yesterday revamped the terms of
its emergency aid to troubled financial firms, setting a
course that could culminate with the government national-
izing some of the country’s largest banks by taking a
controlling ownership stake.

Administration officials said the change, which allows
banks to repay the government with common stock rather
than cash, is intended to give banks more capital to
withstand a continued deterioration of the economy, and
not to nationalize the banking system.

But in seeking to bolster investor confidence in troubled
companies such as Citigroup, the government said it is
willing to acquire large chunks of their shares.

The move is a significant gamble. The magnitude of the
effort could underscore the severity of the crisis, further
alarming investors. The government could also forego
billions of dollars in dividend payments.

Some investors welcomed the announcement. Even as the Dow
Jones industrial average fell 251 points to its lowest
close since 1997, shares of Citigroup climbed 10 percent.
Shares of another troubled firm, Bank of America, rose
about 3 percent.

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The change paves a road toward nationalization for the most
troubled large banks. The government this week will begin
a series of “stress tests” on 20 of the largest banks with
$100 billion in assets to determine how much more capital
these firms need to withstand an extreme recession.

Companies deemed to need more money will be required to
raise it from private sources, or else accept additional
government investments. If those investments are converted
into common shares, even a relatively modest infusion of
taxpayer money could give the government majority control
of many banks because their stock prices have plummeted
in recent months. The total value of Citigroup’s outstand-
ing shares, for instance, is less than $12 billion.

Administration officials said the goal of the revised
program is to give banks a short-term boost that avoids
the need for a more dramatic federal intervention.

What Treasury Secretary Timothy F. Geithner and his team
want to avoid is an explicit takeover that would put the
government in charge of running banks. But some senior
officials have said that, as a last resort, they would
consider taking temporary control of large banks. The
government also could take a majority ownership stake
in a company without attempting to manage its daily
operations.

A wide range of prominent economists and public figures
have called for the government to take this step. But a
backlash is building against government ownership.

Sen. Charles E. Grassley (Iowa), ranking Republican on
the Senate Finance Committee, sent Geithner a letter
yesterday demanding details of the administration’s plans.
“Common stock is riskier than preferred stock. The American
taxpayers are already shouldering a lot of risk these
days,” Grassley said in a statement. “This move could
expose taxpayers to even more risk.”

Even within the government, some senior officials say they
are worried that Geithner’s approach has left investors
unsettled because of ambiguity over the administration’s
intentions.

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The government has invested almost $200 billion in more
than 400 banks under a program created by former Treasury
Secretary Henry M. Paulson Jr. In exchange, the government
received shares of preferred stock that paid an annual
interest rate of 5 percent for five years.

The changes announced yesterday create a two-step process,
officials said. Companies can replace the government’s
preferred shares with a new kind of preferred shares that
will differ in at least one critical respect – they can be
converted into shares of the company’s common stock. The
company can request the conversion at any point during a
specified period of several years, or else the shares will
begin to gradually convert into common shares over time.
If the company does not want to issue common shares to the
government, it must buy back the government’s preferred
shares before the end of the period. Conversions will
require the approval of banking regulators with final
approval from the Treasury Department, a senior
administration official said.

The change in terms could improve the health of banks
without requiring the government to invest additional
money.

Companies that convert the government’s investment to
common shares can reduce required dividend payments,
allowing the largest banks to save billions of dollars.
There is also an important accounting benefit that
improves the value of the government’s investment as a
cushion against future losses.

Under accounting rules, banks are constrained in their
ability to count the money raised by selling preferred
shares under the narrowest definition of that capital
cushion, called tangible common equity. Investors viewing
banks with an increasingly jaundiced eye have increasingly
favored that narrowest definition, and as a result, they
have excluded the government’s initial round of investments
from their calculations of how much money banks hold in
reserve. Issuing common shares would allow banks to improve
their performance on that narrowest measure.

But if the government effort to revive the banks is
unsuccessful, the change unveiled yesterday increases
the risk that billions of dollars in taxpayer money
could be lost. The Bush administration structured its
investments to resemble loans, with regular dividends
and some chance to recover money if a bank fails.
Converting those investments into common shares reduces
or eliminates the dividends and the protections, but it
also allows taxpayers to benefit if companies return to
profitability.

Scott Talbott, a spokesman for the Financial Services
Roundtable, said the changes showed the government’s
support for the industry.

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“This is a signal that the government believes the
financial institutions are strong and provides them
with the flexibility of terms should the economy worsen,”
Talbott said.

Citigroup pushed for the change in terms, according to
people familiar with the matter. The company is walking a
fine line between its need for explicit government support
and its desire to remain independent.

The government already has invested $45 billion in
Citigroup and promised to limit its losses on a portfolio
of more than $300 billion of loans and other troubled
assets. Senior Citigroup executives approached federal
regulators to urge that the government convert parts of
its investment to common shares, the sources said. The
company hopes to reassure investors and attract new money.

David Dreman, chairman of Dreman Value Management, which
as of the end of last year was among the top 70 stake-
holders in Citigroup with more than 9 million shares, said
he was comforted by the government’s latest move yesterday.
“It looks like the government is going to get them out of
this. They’re going to give them enough money so they don’t
go under,” he said.

Brett Hammond, chief investment strategist at TIAA-CREF,
another large Citigroup shareholder, said while a larger
government stake would initially hurt existing share-
holders, it would be better for them in the long run.

“I think you have to take the big view,” he said. “It’s
better for the shareholders for government to take some
action rather than no action. There’s a much better
chance that Citigroup will survive now and therefore
live to pay dividends another day.”

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Staff writers Neil Irwin and Tomoeh Murakami Tse in New
York contributed to this report.

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