Feds explore expanding stakes in nation's struggling banks

JEANNINE AVERSA

WASHINGTON -- The government Monday moved toward dramatically expanding its ownership stakes in the nation's banks -- with Citigroup, the struggling titan of the industry, apparently at the top of the list.

The Treasury Department, the Federal Reserve and other banking regulators said they could convert the government's stock in the banks from preferred shares to common shares.

The strategy, which could be applied retroactively to banks that received money in the first incarnation of the bailout, carries risks. However, it avoids, at least for now, having to tap more taxpayer money or resort to full-fledged nationalization.

Citigroup -- perhaps the biggest name in American banking -- has approached the regulators about ways the government could help strengthen the bank, including the stock-conversion plan, according to people familiar with the discussions. They spoke on condition of anonymity because they are not authorized to speak on behalf of the government or the company. A Citigroup spokesman declined comment.

The stock conversion could be available for other banks as well, the same sources said.

Regulators, reinforcing what the White House has said, insisted that keeping banks private is a priority. But federal officials are walking a difficult line because the government could still have huge stakes in banks.

Citigroup already has received $45 billion in bailout money, plus guarantees to cover losses on hundreds of billions of dollars in risky investments.

"What we are doing here is we're creeping our way toward nationalization," said Terry Connelly, dean of Golden Gate University's Ageno School of Business.

The conversion plan would give the government greater flexibility in dealing with ailing banks. It would give the government voting shares and therefore more say in a bank's operations.

But common shares absorb losses before preferred shares do, which means taxpayers would be on the hook if banks keep writing down billions of dollars' worth of rotten assets, such as dodgy mortgages, as many analysts expect they will.

On the other hand, common stock in banks is incredibly cheap, and taxpayers would reap gains if the banks come back to health and the stock price goes up.

Some economists did not seem much more optimistic than investors.

"I don't think this is the end solution. It is a very haphazard way of trying to deal with the problems and simply postponing the inevitable -- more bank failures and takeovers by the FDIC," said Simon Johnson, former chief economist to the International Monetary Fund and a professor at the Massachusetts Institute of Technology's Sloan School of Management.

It is also far from clear whether the Obama plan would entice private companies to step forward and invest in banks. Treasury Secretary Timothy Geithner has said using both public and private money to restore the banks to health is the plan.

Friedman, Billings, Ramsey & Co. analyst Paul Miller said although the move toward some sort of nationalization might be a "scary proposition for investors," it is likely to provide the quickest and cheapest option to help rid banks of bad assets.

The conversion plan would eliminate the 5 percent dividend that banks already receiving bailout money are currently paying the government on its preferred shares, allowing the banks to hold onto more cash.

It also could bring banks closer to the mix of capital that the government will want to see when it starts conducting its "stress tests" Wednesday to determine the health of banks, experts said.

A government switch to common shares also would reduce the value of shares held by existing stockholders in the bank.

Of the first $350 billion in bailout funds, roughly $250 billion was pledged to provide cash injections to banks. The Obama administration has not said how much of the second $350 billion will be used for that purpose.