In an ominous sign that the financial and economic crisis has spread far and wide, a once laughable and highly unlikely event has come to pass. Our biggest banks are on the verge of being nationalized. That’s right – the government may soon step in and take over America’s biggest banks to save them from collapsing under all their expected debt obligations. But what would happen to your savings, shares and funds that are in these banks? Read on to find out.

Shares of banking giants Citigroup (C) and Bank of America (BAC) hit record lows today on real fears of them being nationalized (put under government control), following comments from influential Senate Banking Committee Chairman Christopher Dodd. White House press secretary Robert Gibbs tried to allay such concerns, saying President Barack Obama's administration thinks a "privately held" banking system is the correct way to go. However he refused to categorically rule out that nationalization may be required in the future.

The persistent weakness of financial stocks underscored deepening worries that months of unprecedented efforts by the Bush and Obama administrations to backstop nearly every corner of the U.S. banking system may not be enough to prevent the nationalization of some of the most wounded institutions. Both banks currently in question came out with statements today saying that they were financially sound and still lending. However a delayed and mixed response from government officials led to the sharp falls in stock prices over the day, despite a modest recovery following White house comments.

Still, the specter of nationalization is now much more real than it once was and you need to know how you will be affected if your bank is nationalized. Here is a breakdown:

Cash, CD and Other Savings held in the bank or its subsidiaries: Your savings are FDIC protected up to the authorized limits ($250,000), just as they are today. So you have little to worry about here since the FDIC is backed by the US government. Still it is always good to have at least a couple of bank accounts (a credit union is even better) to ensure that you have immediate access to cash while a nationalized bank is being taken over. Even if a bank is nationalized it does not mean it will close down. In fact like some recent FDIC takeovers, the process will be quite smooth with staff changes only at the C-level initially. Over time though there be more branch closings, more standardization across bank products and deterioration in customer service as the competitive drive disappears.

Shares invested in the Bank Stock (i.e. Shareholders): Similar to the take-over of GSE’s Freddie Mac and Fannie Mae, common and preferred shareholders will be wiped out. The fact that shareholders are the biggest losers in any nationalization, is the main reason that the stocks of Citigroup and Bank or America fell so sharply today.

Mutual or Exchange Traded Funds that have some investment in the bank’s stock: Most likely they will take a big hit, especially if they are financially focused funds. If it is a cross sector diversified fund the impact will be less because of the smaller financial sector exposure. So review your fund holdings to make sure that they are not too financially centric.

401K or IRA Plans that have invested in the Bank : If you work for one of these banks and have some of or all of your stocks in the bank, then you will be wiped out along with all the other common share holders. If your 401K plan has money invested in a fund then you will be affected like all other fund holders (see above point) and take a hit to your 401K or retirement account.

Other investors in the bank: Bondholders (corporate bonds are sold by the company to bondholders to raise money) MAY be protected if the government honors debt obligations. This will vary on bank-by-bank basis.

Brokerage and Wealth management customers: Banks like Citigroup and Bank or America have large brokerage and wealth management operations as well, which are not part of the core banking functions (saving and lending). If the government takes over, then it will most likely sell these off to private operators. Given brokerage and wealth management functions are quite profitable with low risk they will be easy to sell.

International Investors and Customers: In the case of Citigroup, its vast international scope would further complicate any U.S. government nationalization scheme, because that would run afoul of laws in other countries that restrict foreign governments from controlling domestic banks. In Mexico, for example, where Citigroup controls the nation's No. 2 bank by assets, a law restricts outside governments from owning more than 10% of a domestic bank. Most likely the company would be nationalized in America and operate as a separate entity for international purposes and eventually sold off to companies in the host country.

Despite the word “Nationalization” having a dreadful connotation, it has actually been done quite effectively in the past. Sweden took over its banks during their financial crisis and restored them to health and then privatized them again. France nationalized its banking sector, privatized it again by selling it into private hands and now may be in the process of another wave of nationalization. In the U.S., the government took over hundreds of institutions during the savings-and-loan crisis a couple of decades ago. It aggressively sold off bad assets, and the experiment is now regarded as a success.

We may just be entering another cycle of nationalization though, and the best thing you can do is get informed about its impacts on you and take the relevant actions. Hopefully this post will provide you with some of that information.

Related:

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