Intravenous Intervention
"The conversion feature will enable institutions to maintain or enhance the quality of their capital," according to a joint statement from the U.S. Department of the Treasury, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Reserve Board.
The government had demanded preferred shares as a condition of its $300 billion in TARP investments in 350 US banks. The idea was that government held preferred shares would put the taxpayer at the head of the line for repayment once the banks got their acts together. Although the injection of government capital in the banks kept the patient from dropping dead, it has yet to do anything to cure the underlying infection -- bad mortgage loans. Look no further than Citigroup and Bank of America's stock price since New Year's Day (both down more than 70%).
"Bank losses from residential assets are too large for the banks to earn through the current crises," writes bank analyst Paul Miller of FBR Capital Markets in his latest report.
Converting the governments preferred shares to common stock could do a couple of things. It offers a quick boost to the banks' rapidly shrinking capital base. It reduces repayment pressure on the banks. It might also encourage private investors to place their bets along with the government's. Not unlike an IV drip, these stock conversions will happen slowly over weeks. Medicine (capital) is gradually pumped into the blood stream of the financial system (balance sheets).
Does the government get more of a say holding a huge chunk of common stock? Probably no more than U.S. regulators already have. Remember the U.S. Treasury is already the biggest stockholder in Citigroup and Bank of America. On a number of issues these banks are already taking orders from Washington.
It will be fascinating to see what comes out of the government examination of bank balance sheets that begins this week. Economist Mike Darda of MKM Partners says these "stress tests" could determine whether the government considers something more drastic.
"Once banks' financial health (or lack thereof) is determined, the question then becomes whether to have the government substitute for the private sector with massive further injections of capital, or to restructure insolvent institutions by placing them into receivership, disposing of toxic assets, and selling off the good assets to the private sector."
If the new IV-stock drip fails, the government may be left with few choices short of some kind of takeover of the most distressed banks. Radical therapy indeed.
Guy Campanile is a CBS Evening News Business Producer.