By the middle of the year, the federal government will own large, and in some cases, controlling interests, in two car companies and several major banks. There is a chance the the extent of rescue efforts and government ownership could move to auto parts suppliers and insurance companies. If the Treasury can pick up stock in Microsoft (MSFT) and Intel (INTC), it can control most of the important sectors of the economy. That raises the issue of how the federal government gets all of that taxpayer money back.

The Wall Street Journal has reported that Citigroup (C) and Bank of America (BAC) have done poorly on their “stress tests”. Each bank may be encouraged to raise more capital. As a number of analysts have pointed out, private equity has no interest in stakes in troubled banks even at a steep discount to their current market values. To help improve banks’ capital bases, the Administration will almost certainly have to take the money it has given and is about to give to banks, and convert it into common stock. That will crush current shareholders and it will create the problem of how taxpayers ever get paid back.

It is easy to say that because Citi and B of A are public companies that the government’s shares can be sold. That will be nearly impossible. The minute the Fed signals that it is time for an orderly exit is the minute that other shareholders get panicky, driving the value of the firms down.  In a vicious circle, the value of the government’s interests get depressed by the fact that it would like to get taxpayers their money back. Even if the value of banks rise temporarily. taking the profits off the table will be problematic.

The car industry is not terribly different. If the Treasury controls GM (GM), first it will have to decide how much control it wants to exercise and to what extent it wants to influence company policy. Beyond that, if the company does well, the yield from the government’s investment may be locked up, unless it can find another car company, almost certainly foreign, to take its stake. That brings the conversation around to whether the Congress is anxious for GM to be controlled by VW or Toyota (TM).

If the government ends up in de facto control of two of the largest industries in the country, it probably will not have done taxpayers any favors. Should the economy gets worse, the amount of the government’s ownership, and its exposure, will grow as it protects its investment and support of “strategic” industries with more capital. It is not far-fetched to believe that the Fed could end up having  a 50% stake in Citigroup.

How does the taxpayer even get repaid? Probably through an auction process to sell government holdings in companies that it has rescued.

Suddenly, the government is in the private equity business. Private equity has always had the advantage of leverage. It would buy a company by putting up 10% of its own capital and borrowing 90% from a bank. But, the government has no bank. It can only lend money to itself.

Douglas A. McIntyre

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