Sunday, February 1, 2009

What if Uncle Sam takes over your bank?

Could your bank turn into the Bank of the U.S.A.?

The latest wave of banking problems has investors worried that the government will nationalize deeply wounded institutions, such as Bank of America Corp. and Citigroup Inc.

Such a dramatic step could make it easier for some bank customers to get a loan. And customers with deposits will still be protected by federal insurance, just as they are today. Still, consumers could see more branch closings, more standardization across bank products and a deterioration in customer service. Common and preferred shareholders, meanwhile, will likely get wiped out in a bank nationalization.

With all of the problems that banks are now facing, here is a primer on bank collapses and the impact of possible bank nationalization.

What does "bank nationalization" mean?

A nationalized bank is owned and run by the government. The shocks of the credit crisis last fall spurred lawmakers to seminationalize the banking sector; nearly 314 institutions have already signed over some of their shares and other securities to the Treasury in return for $350 billion in government TARP funds. The government could now go a step further by taking complete ownership of certain troubled banks.

Why nationalize banks?

It makes sense only if banks are in danger of failing. In Western countries, nationalization is largely used as an emergency method to prop up banks during tough times. It is typically used to lend to small and medium-sized businesses and restructure burdensome loans to consumers.

Has nationalization ever worked before?

It has a mixed record. Sweden took over its banks, restored them to health and privatized them again. France nationalized its banking sector, privatized it again by selling it into private hands and now may be in the process of another wave of nationalization. In the U.S., the government took over hundreds of institutions during the savings-and-loan crisis a couple of decades ago. It aggressively sold off bad assets, and the experiment is now regarded as a success.

What will happen to my account if my bank is nationalized?

There should be very little change to consumers' bank accounts and insurance-protection levels if their bank is nationalized. The Federal Deposit Insurance Corp., which insures deposits for up to $250,000, will continue to cover all FDIC-insured institutions, regardless of who the owner is.

And even though an increasing number of banks are failing, the FDIC -- which is backed by the full faith and credit of the U.S. government -- can't run out of money because of its ability to borrow from the Treasury.

Will I be able to get a loan?

Nationalized banks are more likely to loosen the lending spigots. Banks would start making loans that they wouldn't otherwise make today, such as to borrowers with less-than-stellar credit. There would be more pressure to make loans to achieve social objectives.

Homeowners at nationalized banks should also benefit since the government is likely to halt any foreclosure proceedings, says Greg McBride, senior financial analyst at "Uncle Sam is not going to want to put anybody out of their house," he says.

Government-owned banks could offer basic credit cards with low rates that would appeal to less-creditworthy customers who regularly use cards to borrow. But such cards are less likely to come with costly rewards programs, such as those that earn frequent-flier miles, says Dave Kaytes, managing director at Novantas.

How will private-banking and brokerage-account customers be affected?

That depends on whether the government takes a short- or long-term view. If it intends to be a long-term owner, then it will probably sell off the brokerage, investment-banking and other auxiliary operations as nonessential to the core banking business. If, however, the government sees its step as a short-term fix to shore up the system temporarily, then it may hang on to such operations.

What other products and services might be affected?

If the government takes over a bank, management will be under even more pressure to cut costs. Expect more branch closings and poorer customer service. "Think of the bank as the DMV of the future, run by government employees who have little upward mobility," says Mr. Kaytes.

"I think we can expect that over time, the nationalized banks will be less open to innovation and new product development, more conservative in their approaches, and more constrained in their actions and subject to tighter scrutiny," says Jim Eckenrode, banking and payments research executive at TowerGroup.

What are the disadvantages of bank nationalization?

In the U.S., the biggest problem for the government would be the sheer impracticality and expense of taking over all 8,000 banks -- or even the 314 institutions that described themselves as "banks" in order to receive government aid.

The U.S. government would have, at most, the ability to take over only a handful of the most important institutions. As a result, nationalization would not solve the pressing problem of potential bank failures, particularly among small banks. Consumers who have deposits in such banks would still be dependent on the FDIC to return their money during a failure, and such a process could be lengthy and involve a lot of red tape.

Source: The Wall Street Journal (01/22/2009)

No comments: