If Government Converts It Bank Investments To Equity, Common Shareholders Get Killed

The federal government has come up with a new way of taking control of the nation’s largest banks without investing a dime. According to The New York Times, “Treasury Department officials now say they can stretch what is left of the $700 billion financial bailout fund further than they had expected a few months ago, simply by converting the government’s existing loans to the nation’s 19 biggest banks into common.”

The action would have the benefit of government money being changed to capital on the bank balance sheets. It would also allow the Treasury to have a significant say in bank management policies.

If the government makes the move, it would become by far the largest shareholder in a number of the financial firms. It would also dilute current shareholders and could cause bank shares to collapse because of this dilution. It is hard to see why this is good for taxpayers who provided the initial capital which was put into the banks late last year to keep some of them afloat. At Citigroup, which has a market cap of $20 billion, a government conversion of its $25 billion investment could potentially cut the share price of the bank by half. Unless bank stocks stage a huge recovery over the next several years, taxpayers get no benefit. That is the gamble the Treasury and Fed are making.

The Administration may be calculating the Congress will not give it any more TARP money. Too many voters view it as a hand-out to bankers who use the capital to cover fat pay checks instead of to ease credit for consumers and small businesses.

Shareholders at banks like Citigroup (C) and Bank of America (BAC) may be about to get a big shock.

Douglas A. McIntyre