Tuesday, February 24, 2009

Kill all the shareholders? Not so fast...

Advocates for bank nationalization often assert or imply that shareholders who get wiped out will just be getting what's coming to them, or at least that their interests weigh little in the scale against taxpayers'.

But a high percentage of Americans have some exposure to the stock market, mainly through retirement plans (a bit over 50% of households in 2005, according to the Investment Company Institute). And a high percentage of stock holdings in 401ks, IRAs and defined benefit pension funds are in funds that mirror the S&P 500 openly or covertly. We also collectively have an interest in the financial health of colleges, foundations, nonprofits and other mainstays of the institutional investor market.

Shareholders in S&P 500 index funds have already lost a good deal of their equity in bank stocks. On Jan. 31, 2008, financials represented 18.7% of the Index. On Jan. 31, 2009, financials comprised just 10.7%.

So what direct impact would big-bank nationalizations have on stock portfolios? Here are some very rough calculations, powered by my sixth-grade math skills, intended just to get a sense of magnitude, with the understanding that any direct losses would probably be dwarfed by the impact of nationalizations on the whole stock market.

Shares held in the top ten stocks in Vanguard's S&P 500 fund have a combined market value of about $15.5 billion, which represents about 22% of the whole fund, which mirrors the index. The top six banks' combined market value in the fund is just shy of $4 billion, or about 5.6% of the whole. Here they are listed by overall rank:

Institution market value of Vanguard shares (1/31/09)

10) JP Morgan $1,113,453,794
12) Wells Fargo $1,057,060,174
24) Bank of Am $ 667,734,679
35) US Bancorp $ 415,188,109
46) Goldman S. $ 353,070,460
48) Citi $ 345,972,633

Let's say for the sake of argument that Bank of America, US Bancorp and Citi get nationalized, wiping out shareholders. That's something over $1.5 billion in Vanguard's Index 500 fund holdings, or just about 2% of the fund's overall value -- which reflects the proportions of the actual S&P 500.

Of course, these days a 2% loss is a half-day market hiccup. And again, the ultimate impact of nationalization on stock prices, for better or worse, is likely to far outstrip the direct losses to shareholders. The impact of bailouts short of nationalization on taxpayers is beyond my math skills -- perhaps beyond anyone's, since we don't know what the effect of those bailouts would be. But the point remains that shareholders' interests are widely diffused and not to be discounted.

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