Bank nationalization may not as bad as it sounds: I

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What is nationalization
This is my understanding. Usually a company has 3 types of capital: debt, preferred stock, common stock. In terms of ownership the equity holders (common stock holders) own the company. We say they borrow from the debt holders: in return they pay interest and principle to the debt holders down the road.

In the case of bankrupcy, debt holders have priority over preferred holders, preferred have priority over common, etc. (note all debt are not euqal too, some are senior than others, some are secured, some are not).

Back to the topic. Suppose goverment is taking over Citi. The US gov is getting both the potential downside and upside of the Citi. In other words, the gov will assume the liability of Citi’s debt and will own majority of the common stocks (in the case of F2/AIG, they owned warrants equivalent 79.99% of outstanding stocks). So the existing shareholders are diluted, as you can see from the share price of Fannie/Freddie/AIG. The gov can be more stringent if they like. Current law limits goverment ownership under 80%, otherwise the gov needs to combine the balance sheet of those companies into its federal goverment balance sheet (we know US gov has big deficit/debt these days, so the gov is unlikely to expand its balance sheet).

So in other words, nationalization is “mark to market” for exsting shareholders (their securities). Not good news for them.

To be continued…

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