by Calculated Risk on 2/24/2009 02:06:00 PM

From Bloomberg: U.S. Will Take Bank ‘Ownership’ Stakes Only as Losses Climb (ht Anthony)

Federal Reserve Chairman Ben S. Bernanke said the ... Treasury will buy convertible preferred stock as needed in the 19 largest U.S. banks after stress tests to determine how much capital is needed to address losses in a “worse” case scenario, Bernanke told lawmakers at a Senate Banking Committee hearing today. The shares will be converted to common only as the extraordinary losses happen, he said.

“It doesn’t have an ownership implication until such time as those losses which are forecast in the bad scenario actually occur,” the Fed chief said. Bernanke also said that the so- called stress tests that regulators will run on the 19 banks will look at potential losses over a two-year horizon if the economy worsens.

If the banks are seriously insolvent, this sounds like the zombie bank approach and rewards existing shareholders at the expense of taxpayers. If the banks are not seriously insolvent, this is a reasonable approach. But how does Bernanke know the solution before the data is available from the stress tests?