Bernanke Spurns U.S. Control of Banks in Rescue Plan (Update1)

Feb. 25 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke spurned outright federal control of U.S. banks in favor of a public-private partnership that the government would eventually exit.

Bernanke told lawmakers yesterday the government would use supervision instead of shareholder control to guide major banks, and warned against dismantling their franchises. The remarks eased concern Treasury Secretary Timothy Geithner’s financial plan would push aside private shareholders, and spurred the biggest gain in financial shares in a month.

“Bernanke was a voice of reason and he provided clarity in areas where others have failed,” said Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co. LLC in New York. The Fed chairman assured markets that “the nation’s banking regulators were not proposing nationalizing banks.”

The Fed chief’s remarks countered a growing drumbeat among some economists and lawmakers in favor of government takeovers of major financial firms to cleanse them of distressed assets and ensure they keep lending. Establishing ownership control poses legal issues and could undermine banks’ value with private investors, Bernanke warned.

President Barack Obama last night signaled the administration will likely need to expand the $700 billion financial-rescue program to break the back of the credit crisis.

More Money

“This plan will require significant resources,” the president told a joint session of Congress. “And, yes, probably more than we’ve set aside.”

The Treasury will buy convertible preferred stock in the 19 largest U.S. banks if stress tests determine they need more capital to weather a deeper-than-forecast recession, Bernanke said yesterday.

The central banker spoke out amid signs of increasing challenges surrounding the government’s September seizure of American International Group Inc. -- a takeover that predated the government’s $700 billion bank-rescue fund. While AIG planned to repay a $60 billion federal loan by selling businesses, a failure to find enough bids means it may have to hand some operations over to the government, a person familiar with the matter said.

Bernanke said at the Senate Banking Committee hearing yesterday: “I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn’t necessary.”

Investor Concern

Geithner on Feb. 10 provided just an outline of the Obama administration’s plans for buttressing the financial industry. The lack of details led some investors to speculate on their own that a recapitalization of banks would involve substantial government control.

The Standard & Poor’s 500 Banks Index surged 15 percent yesterday to 68.20, taking back more than 40 percent of the losses incurred after Geithner’s presentation.

Senator Christopher Dodd, of Connecticut, the banking panel’s chairman who helped to stir concern about government takeovers in a Feb. 20 interview, said his remarks should have been “better thought-out.” He told reporters yesterday that “banks run by private hands are far more desirable,” after last week saying nationalizations might be needed “at least for a short time.”

“There seems to be a growing sense of relief that nationalization was de-emphasized and put into perspective by Bernanke and some of the people in Congress,” said Marshall Front, who oversees $500 million as chief executive officer of Front Barnett Associates LLC in Chicago.

Hit to Shareholders

Regulators late last year put a priority on preventing the failure of some financial firms, at the expense of common shareholders if necessary. Stockholders of Fannie Mae, Freddie Mac and AIG were all mostly wiped out.

“They learned a hard lesson -- if they nationalize, we are going to find ourselves in a bunch of AIGs,” said Kevin Fitzsimmons, managing director at Sandler O’Neill & Partners LP in New York. “He acknowledged that if the government owns it, the franchise value goes down.”

Bernanke said “the best sign of success” will be when the “government can start taking its capital out or the banks can start replacing the public capital with private-sector capital.”

Joshua Rosner, an analyst at the investment research firm Graham Fisher & Co. in New York, said the government may not run banks with the same sort of control it now has over mortgage finance companies Fannie Mae and Freddie Mac, which are under federal conservatorship.

‘Winding Down’

“But I don’t think we can ultimately resolve the problem without taking some kind of control and forcing the winding down or the sale of certain business units,” Rosner said.

The Treasury’s new convertible preferred stock would be converted to common-equity stakes only as extraordinary losses materialize, Bernanke said yesterday.

“We don’t need majority ownership to work with the banks,” said Bernanke, whose written testimony today before the House Financial Services Committee is almost identical to his remarks before the Senate.

Bernanke also said the so-called stress tests that regulators will run on the 19 banks will look at potential losses over a two-year horizon if the economy worsens.

The assessment will use “both a consensus forecast --where we think the economy is likely to be based on private sector forecasts -- and an alternative which is worse,” Bernanke said.

The Treasury is expected to provide further information about the stress tests today.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net.

To contact the editor responsible for this story: Chris Anstey at canstey@bloomberg.net