WASHINGTON — The Treasury Department appeared closer Thursday to unveiling a program to take equity stakes in banks — but industry representatives were already opposing it while analysts warned such a move carried significant risks.
"Treasury will experience a damned if you do, damned if you don't problem if and when it injects capital in banks," said Laurence Platt, a partner at K&L Gates. "On the one hand, private lenders and investors may be unwilling to invest their own funds if they fear sharing ownership with the federal government. On the other hand, there is no ownership to share if the institution completely fails due to insufficient capital."
Details of the program were not available by press time, but an announcement was expected soon. Dana Perino, a White House spokeswoman, said Treasury Secretary Henry Paulson was "actively considering" direct investment in banks.
Observers said such a plan would likely involve the government's gaining preferred shares in a company in exchange for the capital injection. It is likely to be modeled after recent actions by Warren Buffett, who invested $5 billion in Goldman Sachs and $3 billion in General Electric in return for preferred shares. Those shares would allow stockholders to buy out Mr. Buffett once the companies become profitable again. Though his purchase diluted the value of the companies' shares, in the long run the investors would not be wiped out unless the companies went bankrupt.
If the Treasury imitates such a model, that could resolve one of the chief issues with the plan, observers said. "The most effective form would be something that was broad-based and could allow sound banks to expand their operations. That would be the most constructive," said Lou Crandall, chief economist for Wrightson ICAP.
But some said investors are likely to be unhappy with the plan.
"The main risk from a private-investor perspective is whether Treasury gets to butt to the front of the line, in all issues related to the company," Mr. Platt said. "If it does, then it effectively subordinates the interest of private investors; and investors may not choose to invest their capital in that kind of subordinated investment."
Other observers downplayed this risk and said shareholders would only be hurt in the long run if the capital failed to help the company out of the downturn. In that case, the government would be repaid before existing shareholders. "You either need capital or you don't," said Chuck Muckenfuss, a partner at Gibson, Dunn & Crutcher LLP. "Presumably if the institution is viable and/or they can raise capital at a better price, they would do it."
Some bankers agreed. "There is a scarcity of capital available and banks are having to pay a lot for capital these days," said Bill Demchak, vice chairman and head of corporate and institutional banking for PNC Financial Services Group Inc. "The ability to raise capital today is tight, so having capital coming from the government can be good thing."
Another consideration would be which banks would be targeted or participate in the program. Many observers focused on mid-size banks who are relatively healthy but have had difficulty raising capital or attracting suitors. Examples named were Downey Savings and Loan Association, National City, BB&T and BankUnited FSB.
But it remained unclear whether using the program would be stigmatized. Banks sought for years to avoid using the discount window because those that did were perceived as weak.
"It's both a badge of instability and stability: instability in the sense that governmental assistance was required, and stability in the sense that now they've got the extra capital," Mr. Platt said.
Ed Yingling, the president and chief executive of the American Bankers Association, said recapitalization is a tool for only a "limited number of troubled banks."
He raised questions about restrictions the government would put on the capital. In the bailout law, any assistance comes with executive compensation limits and warrants in the companies. This could discourage involvement.
"It's not just reputational risk; the government's a major stockholder at that point, and in theory this comes with strings attached," Mr. Yingling said. "It is not clear to us why the great, great majority of banks would have any interest."
