Citigroup Moving Towards Nationalization

Debate builds on the topic of nationalizing US banks as Citigroup seems to be headed for that fate. The Obama administration continues to issue statements that assures the market that they favor a policy of a private banking sector. However, slips of the tongue by Federal Reserve Chairman Ben Bernanke seem to indicate that this option is being considered.

The markets anticipates the government converting a large portion of their preferred share into common stock, a move that would give it a 40 percent stake in Citigroup. Lacking clarity as to what that plan might yield, sent the markets into another sell-off.

Both Sweden and Japan nationalized banks in the face of the 1990s economic crisis. And Britain took control of Northern Rock and The Royal Bank of Scotland last year. Neither example provides clear vision as to where a US bank nationalization strategy might take us.

Nationalizing banks do come with perils. In addition to the political pressures and the hazards of keeping failing institutions alive, simple execution could be the challenge. US banks, like Citigroup, are enormously large and complex--Citigroup is eight times as large as Britain's Northern Rock.

Taking over large banks like Citigroup and Bank of America would also potentially wipe out shareholders overnight. This is the major fear that is driving the last couple of day's sell-off of financial services. Meanwhile, bondholders would be big beneficiaries.

Despite the perils there are compelling economic arguments for the move. Lending continues to stagnate. After $350 billion in capital injections there is still minimal lending and toxic assets continue to clog these bank balance sheets.

Bank nationalization may also remove some of the constant uncertainty in the financial sector. Today, much of the problem in restoring confidence in financial institutions is that investors simply don't know what is really hiding in the "books." Nationalizing these big banks would take away the need to manage investor expectations. Ideally this would add transparency and allow for a dramatic clean-up effort.

Certainly this is no one's first preference, but capitalist hawks like former Fed Chairman Alan Greenspan are signally the need for a short-term nationalization plan. The real questions are: first, when do we see a clear plan or definitive ruling out of the option and second, what will the execution look like?