Nationalizing Banks, AIG, Carmakers: The News And What It Means

Nationalizing Banks, AIG, Carmakers: The News And What It Means

UPDATE: A new USA Today/Gallup poll finds that a majority of Americans (54%) favor a temporary government "takeover" of major U.S. banks, but a much lower minority (37%) favor a temporary "nationalization" of the banks.

On Tuesday, President Barack Obama is scheduled to give a sweeping speech of his first year in the presidency, including details of how he will bolster the flailing economy. As Obama develops this plan, there are a number of important factors at work. Among the most critical are the fate of Citibank and the other major banks, the insurer AIG, and the Big Three Detroit automakers. Here is a rundown of some of the most pressing news, and its impact on the economy.

The news:

-The government's $150 billion infusion into AIG appears to be insufficient. According to CNBC, the insurer is preparing to report losses of $60 billion, one of the biggest quarterly losses in history. Click here for background on AIG and news of its financial meltdown.

-The government's $45 billion infusion into Citigroup also appears to be too small. The Obama administration confirmed it is talking to Citi about providing additional funds through the purchase of company stock, which could result in the government owning as much as 40% of the bank.

-General Motors and Chrysler are looking for an additional $22 billion on top of the $17 billion in government funds they have already received.

What it means for banks:

-The billions already spent to prop up banks like Citigroup have failed to staunch the flow of losses. Fearing a chain reaction if Citi fails, the government has announced it will continue to expand its bailout role.

-But the Obama economic team appears to be changing course, leaning closer toward nationalizing the banks. The Treasury Department and the Federal Reserve have announced the government is considering demanding direct ownership stakes in banks that might not otherwise survive the downturn.

-To determine which banks might be too weak to survive, the government is conducting so-called "stress tests" this week.

-If a bank fails the stress test--meaning it needs additional capital to shore up its balance sheets--it must raise funds. And with few private investors willing to invest in the banking sector now, it is likely it will have to tap government funds. Rather than just providing cash, however, the government now says it would make this investment by buying "preferred shares."

-Federal Deposit Insurance Corp. Chairman Sheila Bair spoke about the stress test Tuesday on CBS' "The Early Show.

-Preferred shares do not come with any voting rights, but do pay a dividend to the shareholder, in this case the government. If however, these banks can no longer afford the dividend payments--in the case of Citigroup it amounts to more than $2.25 billion a year--the preferred shares could be convertible into common shares. Common shares don't necessarily pay out a dividend, but would allow the government to vote on appointing key executives and participate in other strategic company decisions.

-Among the problems with the government owning common shares is that it dilutes existing shareholders. As the value of the current shareholders' stock declines, it will make it that much harder for the banks to access private money down the line.

What it means for AIG:

-According to the New York Times:

A.I.G. serves as a cautionary note about the difficulty of luring private investors when the size of the losses is unknown. In the months since the government initially stepped in last fall to take an 80 percent stake in the insurer, the company has suffered deepening losses and has been forced to post more collateral with its trading partners.

-If AIG cannot afford this additional collateral, it faces credit downgrades. This would trigger certain covenants with trading partners that could result in the need to post even more collateral, triggering further downgrades, and so on. This could bring the company to the brink--the same position it was in last September before the government stepped in.

The difficulty of shoring up A.I.G. must weigh on the administration at this moment. The administration's banking statement amounted to a plan of action demonstrating a way to demand a major and possibly a controlling stake in systemically important banks like Citigroup and Bank of America.

-AIG also faces a similar situation as Citi. That's because, according to the New York Times, AIG, in addition to looking for additional funds, is in discussions to convert $40 billion of the government's preferred shares into common equity. That would dilute current shareholders who are already facing massive losses.

What it means for the auto industry:

-The Obama administration is still considering how big a role to play with the Big Three Detroit automakers. On Monday, the Treasury named Steven Rattner, co-founder of a private equity firm, the Quadrangle Group, an adviser to the Treasury on the auto industry.

For more on nationalization look here.

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