Meltdown 101: What it means to nationalize a bank

Buying stakes in troubled banks. Taking control of toxic assets.

Some of the tactics the government has turned to, or proposed, as it tries to rescue the financial system have inspired a discussion of whether the institutions should be nationalized.

But what does it really mean to nationalize a bank? And what are the potential consequences of an expanded government role in the financial industry?

Here are some questions and answers about what this all could mean:

Q: What is nationalization?

A: A textbook definition would say nationalization involves the government seizing control of a private-sector entity by taking a majority stake in it and dictating how it is run.

But that may be too literal for the way "nationalization" is being discussed today. Even without a controlling interest, the government certainly is influencing decisions at the nation's banks after injecting more than $200 billion into them as part of the Troubled Asset Relief Program, or TARP.

At some companies — namely Citigroup Inc. and Bank of America Corp. — the government also has agreed to absorb the losses tied to the banks' most toxic assets, a figure that could run well into the hundreds of billions of dollars.

At banks where the government is the most entrenched, Charles Geisst, a professor of finance at Manhattan College, compares its influence to a father co-signing a car loan for his teenager.

"That sure sounds like the dad is the de facto owner, doesn't it?" Geisst said.

Q: Is more government involvement expected?

A: The TARP, passed by Congress last fall, was originally intended to buy up the toxic assets on the banks' books. Those are the mortgage-related securities and other risky assets that have tumbled in value over the last year, causing big losses for the banks.

But instead of going that route, the Treasury Department decided to use that money to inject capital into the banks as a way to shore up their balance sheets. That has left the banks with troubled assets still on their books.

Given that the losses keep mounting, the government could decide to buy those assets from the banks and hold on to them until they can be sold off at higher rates. That's where nationalization could be expanded.

A big question looms, however: At what price would the government value those assets when buying them from the bank — at the depressed market value, or at a higher rate?

Banking industry consultant Bert Ely said that is a significant obstacle to taking this route. If the assets are bought at depressed prices, the banks will still end up with huge losses on their books. Buying the assets at higher prices, meanwhile, would be very costly for the government, which might never recoup the money.

Q: Who is pushing for nationalization?

A: The idea of nationalization is a political hot potato. Those who are wary of government interference in free markets call it socialism; others seem reluctant to use the term "nationalization," but seem to be supportive of the idea if it would help stabilize the financial system.

In an interview Sunday on "This Week" on ABC, the House speaker Nancy Pelosi was asked about whether the only way to fairly deal with banks that are close to insolvency is through nationalization, or partial nationalization.

"Well, whatever you want to call it," the Democrat from California said. "If we are strengthening them, then the American people should get some of the upside of that strengthening. Some people call that nationalization."

But she also said that she wasn't talking about "total ownership."

"Would we have ever thought we would see the day when we'd be using that terminology? Nationalization of the banks?" Pelosi said.

Q: What are the benefits of nationalization?

When a bank is nationalized, the public's interests are put before shareholders. That means a struggling bank can be restructured in ways that best suit the financial health of the nation.

In addition, if the government bought up the toxic assets, that could wipe out some of the uncertainty that has been plaguing financial markets for months because it hopefully would keep the value of the assets from falling further.

Q: Are there risks to nationalization?

A: If the government begins to nationalize banks, it won't likely be a widespread action but instead will involve only the banks that need it most.

In this scenario, the nationalized banks would be seen as having an unfair competitive advantage over banks that aren't nationalized, Ely said. Private investors might decide to avoid the banks that remain fully private because of the higher perceived risk. And that could bring even more banks to the edge of collapsing.

Q: Are there similar situations the United States can draw on from the past?

A: The U.S government isn't generally in the business of nationalizing private-sector entities, but it has done it before. During World War I, the government nationalized railroads, telegraph lines and the Smith & Wesson Company. During World War II, it seized railroads, coal mines, Midwest trucking operators and many other companies — and even, briefly, retailer Montgomery Ward.

In 1984, Washington seized the failing Continental Illinois Bank and Trust. It continued to exist, with some 80 percent of its shares owned by the federal government, until 1994, when it was acquired by what is now Bank of America.