Bernanke: This isn't nationalization (experts aren't so sure)

McClatchy NewspapersFebruary 24, 2009 

WASHINGTON — Federal Reserve Chairman Ben Bernanke strongly defended the new rescue plan for banks Tuesday, denying that it amounts to nationalization but conceding that because he lacks the authority to close down giant financial institutions, the next-best option is propping them up with taxpayers' money.

The nation's central bank chief also repeated his oft-stated view that the recession could end by the second half of this year if the government succeeds in quelling the banking crisis and getting credit markets back to normal. If that happens, Bernanke told the Senate Banking Committee, "2010 will be a year of recovery."

Bernanke broke ground, however, in discussing the plan announced Monday by five federal regulators that will provide a nearly limitless lifeline to 19 big banks to ensure their survival. Under the plan, these banks would issue a new form of preferred shares to the government that would convert to common stock if the banks needed new capital injections. The common stock issuance would raise the government's stakes in the banks.

Many analysts view this plan as backdoor nationalization because, as losses mount, a bank would need to give the government more and more common stock, potentially giving the government a controlling interest in the bank.

Bernanke testified that temporary government ownership of banks — as some prominent economists and former Fed Chairman Alan Greenspan advocate — is unnecessary. He also denied that the regulators' plan is tantamount to nationalization.

"I would call it private partnership. It's not nationalization, because the banks would not be wholly owned or probably not even majority-owned by the government. The government will be a shareholder along with private shareholders," Bernanke said.

The federal government is expected to take a 40 percent stake in Citigroup this week, the third federal attempt to shore up the international financial giant. Although technically not a controlling interest, the stake is so big that it effectively becomes a controlling stake because the government is both a dominant shareholder and the firm's regulator.

Intrigue arose in the hearing's closing moments, when Republican Sens. Bob Corker of Tennessee and Richard Shelby of Alabama peppered Bernanke with questions that many average Americans share, such as why not just close down some of these big banks?

If only it were that easy, the Fed chief answered. He noted several difficulties in doing that.

"One is just the — the great technical difficulty of shutting down an enormous holding company with many components, an international presence . . . and the implications that would have for market function and market confidence. I think they would be enormous," he said.

Translation: These banks are too big and complex to fail, too interwoven in the global economy. Banking is only one of Citigroup's several divisions. American International Group is similarly complex. Regulators can't just go in and shut them down as they can struggling community banks.

Under questioning from Corker, Bernanke acknowledged that "until it's safe to close down a big firm . . . you're going to be forced to take actions to avoid it." In other words, since you can't bury the body you have to keep trying to resuscitate it.

"To me, it was most enlightening," a frustrated Corker told McClatchy in a telephone interview. "I think it's the first time it's ever been stated so clearly that none of the 19 or 20 (largest) banks will fail, will be seized. It also sounds like it will be some time before private capital returns to those 19 or 20 banks, because it sounds like all capital . . . will be provided by the public sector."

That, Corker said, is de facto nationalization.

"What was said today was the first clarity we've heard about the game plan going forward, and it is, in essence, a creeping nationalization, if you think about it," he said.

Many experts say that the Fed and other federal regulators have little choice because, as Bernanke said, these giant financial firms are bank holding companies, which are different legal entities from mere banks, which the Federal Deposit Insurance Corp. can seize.

"There is no comparable procedure for dealing with the holding companies . . . this is what makes it really sticky. You have to distinguish between banks and their holding companies," said Bert Ely, a banking consultant and expert on the 1980s federal seizure of failed savings and loans. "The least messy way to get out of this is to work with these creatures as they are in their current corporate forms."

The government will be making that important distinction when it begins what it calls "stress tests" on the 19 biggest banking institutions Wednesday. These tests are designed to gauge whether the firms have adequate capital in reserve if the economy sinks from bad to catastrophic. The stress tests won't be just on the banking operations but on the entire holding companies. They'll cover a wide range of complex investments beyond how many toxic mortgage-backed securities they have on their books.

If the government determines that a bank holding company needs more capital, it will direct it to seek private funds — unlikely in today's credit crunch — or to issue the convertible preferred shares that imply rising government stakes in the firm.

As Congress creates a new financial-regulatory structure in coming months, it will get a request for wider authority from Bernanke, who confirmed Tuesday that he'll seek broader regulatory powers that will enable him to do what he can't now: Close a big financial firm.

Lawmakers may want to think long and hard about what such expanded power might mean in the marketplace even if it appears to fix today's problem, cautioned Marvin Goodfriend, an economist at Pittsburgh's Carnegie Mellon University who was a White House senior economist in the 1980s.

"As an ongoing matter, giving the government greater capacity to intervene could make investors shy away in other circumstances," Goodfriend said, suggesting that investors might steer clear of an industry if it's seen as at risk of government intervention. "The country has seen fit to restrict the capacity of government intervention for good reason."

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