Back door nationalization as bailout money may convert to equity stakes

The White House and Treasury Department may decide to convert the government's existing loans to the nation's 19 largest banks into common shares, just like it did with Citigroup (C), in order to stretch what is left of the bailout funds, according to a story in today's New York Times. The Obama administration knows they don't have the votes to get more bailout funds, so by converting the preferred shares, which are similar to debt, to common shares they can raise the equity in the banks and avoid having to give the banks more money.

But the bigger question is what has this money done for us lately? According to The Wall Street Journal, very little. The Journal reports this morning that bank lending has dropped 23 percent since the banks got their cash infusion from TARP. This report will only fuel the fire of the backlash from Congress regarding the banks spending on perks and bonuses rather than lending.

Anyone with a small business who's tried to get credit in the past few months can certainly attest to the fact that lending has slowed. Small businesses around the country have reported that they can't make payroll because their credit lines have been slashed on short-term loans or credit cards. This only adds to the number of people laid off.

By converting the loans to the banks into equity, the Obama administration would have the largest voting stake in many of the big banks. Maybe this will finally get them to rethink bonuses and perks and instead find ways to unfreeze the credit markets. For example, the administration's conversion of Citigroup's loans gave it about a 36 percent stake in the bank.

Some critics wonder whether this is a back door to nationalization. The administration says that converting the preferred stock to common stock is the cheapest way to go. They won't have to contribute any additional cash but it could increase the capital of big banks by $100 billion or more.

But the big question will come when the U.S. has to vote those new common shares. Will there be a conflict of interest when the government looks for ways to maximize the value of the shares held on behalf of taxpayers? Is this attempt to save money a path down a slippery slope to bank nationalization? Is that better than letting some of the zombie banks fail and starting a new banking system without all the baggage?

Lita Epstein has written more than 25 books, including Trading for Dummies and Reading Financial Reports for Dummies.

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