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US vows bank aid; aims to avoid nationalization

business Updated: Feb 24, 2009 09:50 IST

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US regulators promised on Monday to prop up struggling banks if needed and said lenders should remain in private hands, even as a source said Citigroup was in talks to give the government a greater stake.

In Europe, the French government said it was pumping extra cash into two mutually owned banks, and central European central banks took the unprecedented step of talking up the region's currencies.

The Dow Jones industrial average, which started higher on the Citigroup talk, touched an 11-year low on fears that the bank stabilization plan would not be enough to keep the economy from sliding into a deeper hole. U.S. government bond prices rose slightly and the dollar gained against a basket of currencies as investors scrounged for safety.

Amid worries that the United States may still have to nationalize some of its banks, the Treasury Department, Federal Reserve and three other federal agencies said they will start examining large firms' capital needs on Wednesday to determine whether a bigger buffer is warranted.

The money could come from the private sector or the government in the form of preferred shares that convert into common stock over time as needed to ensure banks have enough resources to withstand deepening credit losses.

"Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands," the agencies said.

Healthy banks are vital to stemming recession. While some economists have argued that nationalizing weaker institutions would be the fastest way to revive lending, many investors -- particularly in the United States -- worry that government intervention would have a chilling effect on business.

"If the government tells the bank that they need more capital, it's highly unlikely any 'private' source would step up due to the stigma," said Andrew Busch, global foreign exchange strategist with BMO Capital Markets in Chicago.

"This means that the government's designation could signal a further death spiral for the bank's common stock shareholders," he said.

Citigroup, whose stock has been pounded by fears that the government may seize the bank and wipe out shareholders, was in talks to give the government a larger stake, a person familiar with the matter told Reuters.

The idea under consideration would involve converting a big chunk of the $45 billion in preferred shares the government bought last year into common stock, putting as much as 40 per cent of Citigroup into public hands.

The British government announced a similar move last month, saying it would convert preferred shares in Royal Bank of Scotland, which is expected to announce more restructuring this week.

France on Monday also reached out to its lenders, pledging up to 5 billion euros ($6.3 billion) in additional aid for Banque Populaire and Groupe Caisse d'Epargne.

The two mutual banks are expected to detail a merger this week and the new aid could give the government a stake of up to 20 per cent in what is set to be France's second-biggest retail bank behind Credit Agricole.

Losses mount

Banks around the world have already reported hundreds of billions of dollars in losses and write-downs as defaults spike on mortgages, credit cards, corporate debt and a host of other loans.

JPMorgan Chase & Co, the second-largest US bank and considered to be among the strongest, slashed its common stock dividend by 87 per cent in a surprise move to preserve a "fortress" balance sheet against any worsening of conditions.

American International Group, once the world's largest insurer, may be coming back for its third round of US government aid as losses and writedowns mount, according to a source and a CNBC report.

Dresdner Kleinwort economists think corporate bankruptcies worldwide will rise by at least 20 per cent this year, after a 14 per cent increase in 2008.

Governments have responded by stepping up spending and tax cuts to try to cushion the blow. Despite the spending spike, US President Barack Obama pledged to halve the budget deficit in the next four years.

In the auto industry, one of the hardest hit by the credit contraction and consumer spending slump, Ford reached a tentative agreement with the United Auto Workers union on changes to a retiree health care trust, becoming the first Detroit automaker to secure union concessions on the key issue.

European Central Bank President Jean-Claude Trichet said on Monday that the financial crisis was spilling over into the wider economy and that the euro zone's financial system is under "severe strain."

Latvia's government collapsed on Friday and the currencies of countries such as Poland, the Czech Republic and Hungary have come under severe pressure, hitting millions of citizens who have borrowed in foreign currencies such as the euro.

Emerging European Union central banks coordinated to prop up their currencies on Monday, with Czech central bank Governor Zdenek Tuma saying they had agreed that recent falls were overplayed.