The banking sector keeps hitting new lows every day, led by Citigroup (NYSE:C) and Bank of America (NYSE:BAC), as rumors continue to sweep the market that the government will nationalize two of the largest banks in the world and wipe out stakeholders. Can the government do this? And would it work if it did? What would come next? Nationalization probably wouldn't solve our financial crisis.


IN PICTURES:
Eight Ways To Survive A Market Downturn

The word "nationalization" itself conjures up images of the tired old stereotype of the leader of a Banana Republic seizing Yankee property and chasing the imperialists out of the country at gunpoint. Unfortunately for the U.S. financial system, this is not the United Fruit Company and Guatemala, or Fidel Castro marching into Havana on New Year's Day in 1959.

Can The Government Do It?
Absolutely. The two institutions are bank holding companies that, depending on their charters, are regulated by either the Federal Deposit Insurance Corporation (FDIC) or the Federal Reserve. The government could nationalize the banks officially by seizing them late on a Friday evening, which the FDIC has done many times over the last year. Alternatively, it could do it unofficially by browbeating management to take more dilutive capital infusions, or by setting up a conservatorship in the manner of Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE). Either way, equity and bond holders would be wiped out. (To learn more about the FDIC, be sure to read our related article The History Of The FDIC.)

Would It Work?
This is a more difficult question, because I am not sure what would be accomplished by nationalization. The so-called toxic assets would still be on the balance sheet of some entity, whether it's the government or the private sector. If the government did a typical bank seizure, it would try to sell the deposit base and the loan assets to another institution. Due to the size involved, this may not even be possible. The government would be stuck with billions of dollars in non-performing loans and billions more in toxic securities. When the government sells these at fire sale prices, imagine how badly that would make other financial institutions mark down their security portfolios.

What Would Come Next?
Right behind these two institutions are two other large banks, Wells Fargo (NYSE:WFC) and JP Morgan (NYSE:JPM). Wells Fargo bought Wachovia, so some issues are probably lurking there, and while Jamie Dimon at JP Morgan established a reputation for managing his institution the best during the crisis so far, the bank is not immune from the issues facing the rest of the industry. It also has toxic assets and deteriorating loan asset quality. So, once the Obama administration panders to the market and feeds it the carcasses of Citigroup and Bank of America, why stop there? Should it throw the next two banks to the market to be torn apart? Why not the entire banking system? Perhaps the president should realize that the market is not a God, and as a value investor would say, it is irrational in the short term.

Managements of both Citigroup and Bank of America tried to downplay the nationalization talk. Citigroup cited its high Tier 1 capital of 11.9%, and Ken Lewis, the CEO at Bank of America, said the talk "is based on a lack of understanding of our bank's financial position as well as a lack of appreciation for the adverse ramifications for our customers and the economy".

Nationalization Is Not A Panacea
However the situation resolves itself, it is clear that the financial crisis has a long way to go, and the new administration was not the panacea that everyone thought it might be. Neither is nationalization.

To learn more about the financial crisis and what you can do to make it through, check out our Financial Crisis Survival Guide Special Feature.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  3. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  4. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  5. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  6. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  7. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  8. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  9. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
  10. Investing News

    Alphabet Earnings Beat Expectations (GOOGL, AAPL)

    Alphabet's earnings crush analysts' expectations; now bigger than Apple?
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center