What do you call a U.S. banking system with heavy government ownership?

No, that’s not the start of a joke. Just the start of a lengthy dance over whether the government will end up taking over major banks.

Sens. Dodd and Johnson talk while Sen. Shelby questions Chairman Bernanke. (Getty Images)

With talk of nationalization spreading, Federal Reserve Chairman Ben Bernanke spent much of today’s Senate Banking Committee hearing hearing trying to squash the growing belief that the government needs to seize struggling banks to restore the financial system to health. “We don’t need majority ownership to work with the banks,” Mr. Bernanke said. “We have very strong supervisory oversight. We can work with them now to get them to do whatever’s necessary to restructure, to take whatever steps are needed to become profitable again, to get rid of bad assets. We don’t have to take them over to do that.

“I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn’t necessary,” he said.

The Fed chairman didn’t explain what it means to “formally nationalize” a bank. But his comments implied that majority ownership translates into a form of nationalization. The key question on lawmakers’ minds — how much more money they’d have to cough up — tied directly to the government’s current dilemma over whether some banks will need such large capital injections that they’d become majority owned by taxpayers. (Mr. Bernanke declined to provide a precise estimate for the total cost, instead deferring to the Obama administration, which gets to make that decision.)

The government’s bank stress tests, starting Wednesday, will assess whether about 20 major financial institutions — those with $100 billion or more in assets — have adequate capital to ride out the downturn. They’ll be analyzed over a two-year horizon under conditions significantly worse than the housing market and overall economy are experiencing today.

“We’re going to do an honest evaluation,” Mr. Bernanke said. “We’re going to do a tough evaluation, to try to figure out how much hole there is, if there is a hole.”

Sen. Richard Shelby, the committee’s top Republican, pressed on the key point: “Do you believe that most of those banks can withstand the stress test?”

Mr. Bernanke’s answer suggested the government isn’t looking to shut down deeply troubled banks at the end of the process, as many investors have assumed. “The outcome of the stress test is not going to be fail or pass,” Mr. Bernanke said. “The outcome of the stress test is how much capital does this bank need in order to meet … the credit needs of borrowers in our economy.”

Translation: The government will fill the capital hole. Mr. Bernanke acknowledged “there will be some public ownership” through common stock. The government capital, in the form of convertible preferred shares, would initially serve as a buffer against losses rather than outright ownership, he explained. When the losses actually occur, the bank could convert the preferred shares to common stock to ensure it has enough equity. “Only at that time, going forward, if those losses do occur, would the ownership implications become relevant.”

Sen. Bob Corker (R., Tenn.), who has a gift for saying he’s not criticizing government officials and then criticizing them, called Mr. Bernanke’s explanation “probably the most enlightening thing that’s been said in the last five weeks as far as where we’re going.”

Then, Mr. Corker said: “But it seems to me that this has been creating this sort of dead-man-walking, sort of zombie-like banking scenario. … In essence, this is a form of sort of creeping nationalism, right?”

The two danced around quite a bit longer before Mr. Corker flat-out asked for “a term to use as I leave here as to what we would call that,” referring to Mr. Bernanke’s explanation of the government’s plans.

“Call it a public-private partnership,” Mr. Bernanke said. “It’s not nationalization, because the banks would not be wholly owned or probably not even majority owned by the government. The government will be a shareholder, along with private shareholders.”

Mr. Bernanke later objected to the term “zombie,” saying that all the 20 banks are lending and active. But Mr. Corker would not relent, suggesting that Mr. Bernanke implied the banks would keep getting government money to survive. “That absolutely means that none of 20 major banks in our country ever have the chance of being seized,” Mr. Corker said of the Fed chairman’s comments.

“Senator, it’s not a statement of principle, or forever,” Mr. Bernanke said. “Based on our knowledge of those banks and where they are, and where we think they’re going to come out, we believe this is the best way forward.”

Nationalization, partnerships or zombies — all require money. And how much money still isn’t clear. –Sudeep Reddy"