All Bailed-Out Banks Can Get Citigroup’s Good Deal — And Guess Which Party is Raising the Alarm?

The wall-to-wall media coverage of President Obama’s speech last night pushed the growing controversy over bank nationalization into the business pages this morning, but Federal Reserve Chairman Ben Bernanke made a stunning admission yesterday before the Senate Banking Committee.

The government’s latest rescue offer to Citigroup, in which Uncle Sam would convert its preferred-stock investment in the bank into common stock — forgoing the 5% dividend and extra rights that preferred shareholders enjoy — isn’t just available to Citi, as Bernanke said yesterday. Any of the 19 banks that are in line for upcoming Treasury Department “stress tests” can get a preferred-to-common conversion if expected capital losses materialize.

Giving major banks another break at the taxpayers’ expense would seem to be a highly controversial proposition in Congress, particularly when the conversions are expressly designed to help Citigroup and its cohorts do better on the “stress tests.” But so far, the only lawmakers raising red flags on the stock conversions are Republicans.“Candidly, it’s very troubling,” Sen. Bob Corker (R-TN) told me after the Bernanke hearing, calling the stock conversion plan “creeping nationalization” and likening it to the often-haphazard initial bailout concocted by the Bush Treasury Department: “It’s more of the same on steroids.”

Sen. Lindsey Graham (R-SC), who has already supported a temporary government takeover of banks that fail the “stress tests,” wondered whether the description of major banks as “too big to fail” is a more palatable way of saying they’re “too big to liquidate quickly.”

“Does it make sense to infuse more money into AIG?” Graham asked me by way of example, before offering a qualified answer. “What if you could show me that the failure of AIG would hurt more … if you could show me that converting preferred stock to common stock [would be a better deal]?”

To be sure, opinions on government control of the banks transcend party lines and are constantly shifting. Banking Committee Chairman Chris Dodd (D-CT) yesterday backtracked a bit on his recent acknowledgment that nationalization would have to be on the table. But Dodd’s GOP counterpart on Banking, Richard Shelby (AL), is already wondering whether Citigroup-style stock conversions are nationalization with a prettier face.

Here’s how Shelby put it at yesterday’s hearing (mistakenly referring to Citigroup by its old name, Citicorp):

I think you can take over a bank by converting the preferred [to common shares] and, as you were talking about Citicorp or some of them are doing about doing, and you have — if you had 40 percent working control of Citicorp, you basically would — you wouldn’t own it all, but you’d own working control probably. And you would be the — the big power in the boardroom, so to speak.

Another Republican, Chuck Grassley (IA), was the first out of the gate criticizing the preferred-to-common stock conversion. In a Monday letter to Treasury chief Tim Geithner, Grassley noted that converting government stock would likely exempt Citigroup from the new executive compensation limits that Congress added to the stimulus law — which amounts to a major victory for K Street, achieved through the back door. Grassley said:

Common stock is riskier than preferred stock. The American taxpayers are already shouldering a lot of risk these days. This move could expose taxpayers to even more risk. Also, if it allows Citigroup to circumvent executive compensation restrictions, that will add insult to injury for the taxpayers. We all need to know what Treasury hopes to accomplish here and whether the risks are worth any benefits.

Will these GOP skeptics press their party to take an active stance against the stock conversions for bailed-out banks? It’s very unlikely, given that no Republican has offered a workable alternative to the “stress test” approach.

And Bernanke even admitted yesterday that the government has no rule book to “address the potential failure of a systematically critical firm, like AIG,” asking Congress to give the Federal Reserve instructions on the issue as part of its upcoming financial regulation package. “[U]ntil it’s safe to close down a big firm … you’re going to be forced to take actions to avoid it,” Bernanke said.