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Treasury to Revitalize Banks in the Short Term

Last year’s plan is finally on the way.

The New York Post released a plan by the U.S. Treasury Department that will hopefully raise new capital for distressed banks. The office will be accepting warrants in an effort to keep banks from being nationalized. The Post states, “The move to accept warrants – the right to purchase shares in the future at a pre-determined price – will play out next week as Treasury gets results from the first round of its crucial stress tests.”

In October of last year, Former Treasury Sec. Henry Paulson released in an official statement, “As we have designed the program, Treasury will make $250 billion in capital available to U.S. financial institutions in the form of preferred stock. (Institutions) will not only own shares that should be paid back with a reasonable return, but also will receive warrants for common shares in participating institutions. We expect all participating banks to continue to strengthen their efforts to help struggling homeowners who can afford their homes avoid foreclosure. Foreclosures not only hurt the families who lose their homes, they hurt neighborhoods, communities and our economy as a whole.”

The banks were determined last November by CFO.com that included Bank of America, Bank of new York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, Wells Fargo, and Merrill Lynch.

So how can this avert bank nationalization then?

For it to happen, the government would be forced to take over a bank by purchasing its preferred stock only when large banks are on a distress and would cause a severe impairment in the economy. Though we’ve seen the fall of Lehman Brothers and Washington Mutual, there’s no clear sign yet if the government will be in control of their operations since the bailout funds do not have such explicit detail. We haven’t even heard of the Treasury mandating new lending requirements after this. On the other hand, it is slowly exercising its control over Fannie Mae and Freddie Mac that are currently under conservatorship.

There are three things that could happen if banks are nationalized. First, a large bank will be forced to become a “social bank” since the government will be directing the loan funds to the marginalized over less risky enterprise developments in a free market. A middle-income homeowner may not be able to refinance because the loan will now be allotted for a low-income renter who needs to build a house. Second, politicians will be exerting pressure as to where the money shall be appropriated because the government is already in command. Third, national banks are given the liberty to price their products and services according to their profitability goals. This provision can be abused by politicians who will turn the institution into a piggy bank for their self-interest even though such move is contrary to the law.

So by accepting warrants then, it is a safer option for the Treasury to allay down fears of nationalization since it would not constitute the purchase of preferred stocks by these large banks. In other words, it will not have any voting rights but still guarantee itself as lifeblood to the troubled balance sheets of these financial institutions.

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