Should the government convert preferred shares to common equity?

Some interesting points were raised in the comments attached to Paul Krugman's blog latest blog entry:

Now, preferred shares are sort of like a junior loan: the preferred shareholders are second in line for losses, but ahead of the rest of the bank’s creditors. So from the point of view of the creditors, capital includes preferred shares as well as common equity. Or to put it a bit more generally, from a creditor’s point of view capital is everything that has a more junior claim than you do.

And that’s why Tier I capital includes preferred as well as common.

But in that case, converting preferred into common does nothing: it’s just a swap among the junior stuff, with no impact further up the line. It’s certainly not a fresh infusion of capital in any meaningful sense.

Some of the possible positives affects of converting the preferred shares to common are (taken from the comments):

1. It would help persuade private capital to invest in preferred shares, since the government’s share is now more junior rather than on an equal footing.
   
2. The banks will be relieved of interest obligations, increasing their net income. This will provide some additional relief to the banks without requesting new funds from Congress.
   
3. Managers maximize the value of common stock. Limited liability means that a distressed bank will have perverse incentives until it has enough common stock to absorb those losses. Managers running mega banks with too little common equity will be tempted to make speculative loans and shift those losses onto senior creditors (preferred stockholders and bondholders). With too little common equity banks will pass up good loans because too many of the gains are realized by preferred stockholders and debt holders. As long as the government gets a decent conversion price that reflects the market value of their preferred holdings, converting preferred to common stock is a great idea that will improve lending incentives.
   
4. Now that bank shares are rallying, the conversion might be a convenient way for the holders of the preferred shares to dump them on the rest of the market before the rally ends. If the TARP secures some cash for itself this way, it could be used to make the banks a little more solvent.
   

5. This is not a mere swapping of deck chairs: Preferred stock pays guaranteed dividends, common equity does not.If they are no longer obligated to pay these dividends, the banks will recapitalize faster (through retained cash flows/earnings) and thus be restored to health.I think this plan makes more sense from the perspective of optimizing the cycle / intertemporal substitution: Banks should sensibly pay out cash in a cyclical fashion. The new policy helps banks manage the cycle from the present downturn, so that in the (better) future there is more pie left for the taxpayers.

As far as I am concerned, you can name all the positives you want; the US government being the largest shareholder (via common equity) with voting rights at these banks its a receipt for disaster. We have already seen the Congressman trying to bully these banks for not making loans in the middle of a recession. This bully was done without having voting rights. Imagine how this scenario would play out if Congress had had voting rights at the time. I don't want to image this, and neither should you.