The Treasury Department's plan to invest up to $250 billion in at least nine and potentially thousands of financial institutions may let it steer long-scrutinized consumer lending products and practices, observers said.
Any such investment would be a far less severe change for a financial institution than being taken over by the government, which was the fate of IndyMac Bank, Fannie Mae, Freddie Mac, and American International Group Inc. this year. The government would get nonvoting preferred shares, and warrants to buy common shares, in the banks and thrifts, but only in certain circumstances would it get board seats.
Still, since they came under government control, Fannie, Freddie, and IndyMac have increased their efforts to modify mortgages to avoid foreclosure — setting a precedent for the government to exert at least indirect sway over the mortgage and other consumer lending practices of its new holdings.
"I do not think they're going to say, 'You may not issue X, Y, or Z.' I think they're going to say, 'If you offer X, make sure you understand it,' " said Brian W. Smith, a partner with Latham & Watkins LLP and a former chief counsel at the Office of the Comptroller of the Currency.
"It is entirely possible that some selected practices will go by the boards," he said, though "I don't think this increased investment or involvement by the government automatically results in a change in every banking practice."
Aside from how the Treasury manages the stakes, "the price that will be paid for all of this injection of capital and the removal of troubled assets of banks' balance sheets will be heightened regulatory scrutiny," Mr. Smith said.
"I think the banks will see a palpable difference in their contacts with their regulators. … There will be tightened controls over lending standards" and "heightened emphasis on disclosures and the clarity of those disclosures."
Adam Levitin, an associate professor at Georgetown University Law Center, said he expected the government's investments to have very little impact on consumer products, with the possible exception of some mortgage modifications.
"For mortgages that are wholly owned by financial institutions, there we could expect to see the government pushing for greater modifications, or maybe the government just buys the mortgages outright," he said.
For other consumer lending practices, however, "the OCC has tremendous soft-power influence if they want to exert it, but the problem is they rarely choose to exert it," Prof. Levitin said.
"The first priority is not going to be reforming consumer lending practices. The first priority is just stabilizing institutions."
Consumer lending reform is on hold until the next administration comes into office, Prof. Levitin said, but by then it may be too late for the Treasury, as preferred shareholder, to shape practices.
"If Treasury wants to exert influence, now's the time," he said. "Down the road, the banks have the money," and will be less likely to take cues from their new nonvoting shareholder.
Joseph Mason, an associate professor of finance at Louisiana State University, called the potential for the government to direct banks' practices in a new and undefined way "one of the risks" of its new role as an investor.
"Without the standard corporate governance avenue to control through voting rights, we're left to an ad hoc approach," said Prof. Mason, a former economist at the OCC. "We're kind of inventing a new role for the government in private enterprise," which could be a "huge potential threat and a potential unintended consequence."
Any changes by the government should be made through more traditional channels, he said.
"Every financial crisis, this one included, is caused by a lag in regulations," Prof. Mason said. "We need to continuously improve regulations going forward, not set it and forget it in the same way. … We should hope that regulations in general do the job, not the specific intervention of having to have a government manager look over your shoulder."
Consumer advocates expressed little optimism about the likely impact of the Treasury's new role in financial institutions, though they said the government is taking on a larger role than a typical nonvoting shareholder.
"With this investment comes great responsibility on the part of the federal government to ensure that they are not funding practices or products that harm consumers," said Travis Plunkett, the legislative director of the Consumer Federation of America.
He said that he could not predict how the government would meet that responsibility, but that its status as a nonvoting stockholder would not be a significant impediment if it chooses to exert influence.
"The government will not be just any old minority stakeholder," he said. "Even private shareholders who have this size of a stake in financial institutions have considerable power."
John Rao, an attorney at the National Consumer Law Center in Boston, said his nonprofit held a meeting Tuesday to discuss whether the government's purchase of bank equity would "provide an opportunity for there to be some change at financial institutions."
But "it's just so hard to know to what extent the government will try to exert influence, and I have a feeling there will be a real push-back to that" from the banks, Mr. Rao said.
At the very least, the Treasury's purchasing of preferred shares in banks "should make it much harder for institutions to not respond" to calls for more modifications of home loans, he said.
The Treasury, which unveiled the plan Tuesday, did not return calls for this story. The money for the stakes is to come from the $700 billion rescue package Congress recently passed.
Tom Kelly, a spokesman for JPMorgan Chase & Co., one of the nine institutions that have agreed to sell stakes under the plan, said it is "too soon to tell" how the investment would affect recipients' consumer lending practices.