US Partially Nationalizing Top US Banks - Citi, Bank of America, Morgan Stanley, Goldman Sachs, and More

The WSJ, Bloomberg, and almost every other business news source is reporting that the US Treasury has decided to forcibly inject capital into several key US banks to prop them up and dispel any uncertainty about their viability. According to sources, none of the banks were given a choice. Paulson and Benanke showed up and basically laid down the law. Which is correct. The banks have so screwed up their own finances and that of the country that they long ago lost their right to act independtly. To me, a forced move like what is being reported is tantamount to a partial nationalization of the banking system.

The amounts and the banks include:

• $25 billion to Bank of America, J.P Morgan and Citigroup.
• Between $20 and $25 billion in Wells Fargo
• $10 billion in Goldman and Morgan Stanley
• Between $2 billion and $3 billion in Bank of New York Mellon and State Street

In return for its investment, the government, or rather us, are supposed to receive preferred shares. I wonder how that will work? Looking at just Bank of America, the company as of closing today had a market cap of approximately $100 billion. A $25 billion investment theortecially gives the government a 25% stake in the company. Will the government take a 25% stake? Will they be able to act as a shareholder? Do the preferred shares work differently?

In addition to the forced capital injections, the plan will:

• Guarantee all new debt issue for banks and thrifts for the next three years.
• Offer unlimited deposit insurance coverage to non-interest bearing accounts. I assume this means DDA and checking accounts. I'm not sure why this doesn't extend to savings and cds.
• Put caps on executive compensation to all executives of the companies that have received Federal Funds. Say goodbye to all of the MBAs flooding into the investment banks. If the CEOs pay gets cut, guess what happens to everyone else at the company. Working for a bank just officially became a lot less lucrative.

The big question is whether it will all work. On that, the feedback is mostly positive. While many ecnomists and banking experts were hostile to Treasury's original plan to buy distressed assets from these banks, almost everyone seems to agree that this is a prudent plan that should help. Quoting from the WSJ:

William Poole, former president of the Federal Reserve Bank of St. Louis, was a fierce critic of Treasury's initial plan to buy up distressed mortgage-backed securities. Such a scheme, he said, would lead banks to dump their worst assets on the taxpayers.

But Treasury's new tack may well do the trick, said Mr. Poole, now a senior fellow at the free-market-oriented Cato Institute.

"Investors need to be confident that the banks they're dealing with are unquestionably solvent, and it's in the interest of banks to assure investors that that's the case," Mr. Poole said. "One way banks can provide that assurance is to raise additional capital, in some combination of private and government capital."

Let's hope he is right.