Citigroup and Bank of America may need new capital

Each day there are more rumors about which of the 19 banks given government stress tests may have to raise more money. Last week it was regional banks in the Midwest and South that had extensive exposure to commercial real estate. Now the speculation has turned to Bank of America (BAC) and Citigroup (C), which each got extensive federal financial support last year.

One of the by-products of a larger investment in the two big money center banks is that the government could have to put in so much money or convert its preferred shares to common that it would end up owning a majority of the banks, just the way it may with GM (GM). That will mean extensive dilution for current shareholders.

According toThe Wall Street Journal, "Regulators have told Bank of America Corp. and Citigroup Inc. that the banks may need to raise more capital based on early results of the government's so-called stress tests of lenders." Apparently the banks are debating the findings.

There has been a lot of speculation about what happens if the federal government does hold a majority of the largest banks. Who controls the boards? Will the government veto important management decisions?

It seems that the solution to the problem is simple. The government should auction off its equity in the banks, even at a discount. The argument against this is that taxpayers will miss out on the "upside" if banks do well. The argument for it is that taxpayers will be at risk for the "downside" if bank results get worse.

At the very least, there should be a process of hedging bets. Having so much taxpayer money in one or two baskets is a bad idea. At least a portion of the equity stakes should be laid off to private equity investors.

Douglas A. McIntyre is an editor at 24/7 Wall St.

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