US May Take Ownership Stake in Banks

Published on
by
The New York Times

US May Take Ownership Stake in Banks

by
Edmund L. Andrews and Mark Landler

The Treasury Secretary Henry Paulson at a news conference on Wednesday. (Shawn Thew/European Pressphoto Agency)

WASHINGTON - Having tried without success to unlock frozen credit
markets, the Treasury Department is considering taking ownership stakes
in many United States banks to try to restore confidence in the
financial system, according to government officials.

Treasury officials say the just-passed $700 billion bailout bill
gives them the authority to inject cash directly into banks that
request it. Such a move would quickly strengthen banks' balance sheets
and, officials hope, persuade them to resume lending. In return, the
law gives the Treasury the right to take ownership positions in banks,
including healthy ones.

The Treasury plan was still preliminary and it was unclear how the
process would work, but it appeared that it would be voluntary for
banks.

The proposal resembles one announced on Wednesday in Britain. Under
that plan, the British government would offer banks like the Royal Bank
of Scotland, Barclays and HSBC Holdings
up to $87 billion to shore up their capital in exchange for preference
shares. It also would provide a guarantee of about $430 billion to help
banks refinance debt.

The American recapitalization plan, officials say, has emerged as
one of the most favored new options being discussed in Washington and
on Wall Street. The appeal is that it would directly address the
worries that banks have about lending to one another and to other
customers.

This new interest in direct investment in banks comes after yet another tumultuous day in which the Federal Reserve
and five other central banks marshaled their combined firepower to cut
interest rates but failed to stanch the global financial panic.

In a coordinated action, the central banks reduced their benchmark
interest rates by one-half percentage point. On top of that, the Bank
of England announced its plan to nationalize part of the British
banking system and devote almost $500 billion to guarantee financial
transactions between banks.

The coordinated rate cut was unprecedented and surprising. Never
before has the Fed issued an announcement on interest rates jointly
with another central bank, let alone five other central banks,
including the People's Bank of China.

Yet the world's markets hardly seemed comforted. Credit markets on
Wednesday remained almost as stalled as the day before. Stock prices,
which had plunged in Europe and Asia before the announcement, continued
to plummet afterward. And stock prices in the United States went on a
roller-coaster ride, at the end of which the Dow Jones industrial
average was down 189 points, or 2 percent.

The gloomy market response sent policy makers and outside experts on
a scramble for additional remedies to stabilize the banks and reassure
investors.

There is no shortage of ideas, ranging from the partial
nationalization proposal to a guarantee by the Fed of all lending
between banks.

Senator John McCain,
the Republican presidential candidate, on Wednesday refined his
proposal - revealed in a debate with the Democratic nominee, Senator Barack Obama, the night before - to allow millions of Americans to refinance their mortgages with government assistance.

As Washington casts about for Plan B, investors are clamoring for
the Fed to lower interest rates to nearly zero. Some are also calling
for governments worldwide to provide another round of economic stimulus
through expensive public works projects.

Yet behind the scramble for solutions lies a hard reality: the financial crisis has mutated into a global downturn that economists warn will be painful and protracted, and for which there is no quick cure.

"Everyone is conditioned to getting instant relief from the
medicine, and that is unrealistic," said Allen Sinai, president of
Decision Economics, a forecasting firm in Lexington, Mass. "As hard as
it is for investors and jobholders and politicians in an election year,
this crisis will not end without a lot more pain."

One concern about the Treasury's bailout plan is that it calls for limits on executive pay
when capital is directly injected into a bank. The law directs Treasury
officials to write compensation standards that would discourage
executives from taking "unnecessary and excessive risks" and that would
allow the government to recover any bonus pay that is based on stated
earnings that turn out to be inaccurate. In addition, any bank in which
the Treasury holds a stake would be barred from paying its chief
executive a "golden parachute" package.

Treasury officials worry that aggressive government purchases, if
not done properly, could alarm bank shareholders by appearing to be
punitive or could be interpreted by the market as a sign that target
banks were failing.

At a news conference on Wednesday, the Treasury secretary, Henry M. Paulson Jr.,
pointedly named the Treasury's new authority to inject capital into
institutions as the first in a list of new powers included in the
bailout law.

"We will use all the tools we've been given to maximum
effectiveness," Mr. Paulson said, "including strengthening the
capitalization of financial institutions of every size."

The idea is gaining support even among longtime Republican policy
makers who have spent most of their careers defending laissez-faire
economic policies.

"The problem is the uncertainty that people have about doing
business with banks, and banks have about doing business with each
other," said William Poole, a staunchly free-market Republican who
stepped down as president of the Federal Reserve Bank of St. Louis on
Aug. 31. "We need to eliminate that uncertainty as fast as we can, and
one way to do that is by injecting capital directly into banks. I think
it could be done very quickly."

Mr. Paulson acknowledged that the flurry of emergency steps had done
little to break the cycle of fear and mistrust, and he pleaded for
patience.

"The turmoil will not end quickly," Mr. Paulson told reporters on
Wednesday. "Neither the passage of this law nor the implementation of
these initiatives will bring an immediate end to the current
difficulties."

Mr. Paulson will play host to finance ministers and central bankers from the Group of 7 countries this Friday. But he cautioned against expecting a grand plan to emerge from the gathering.

More likely, the participants will compare notes about the measures
they are adopting in their own countries. David H. McCormick,
Treasury's under secretary for international affairs, said there was no
"one size fits all" remedy for the crisis, though countries were
cooperating through the coordinated cuts in interest rates, with
guarantees on bank deposits and in regulations.

At the Federal Reserve in Washington, officials insisted they had
not run out of options and made it clear they were willing to do
whatever it took to shore up the economy.

Fed officials increasingly talk about the challenge they face with a
phrase that President Bush used in another context: "regime change."

This regime change refers to a change in the economic environment so
radical that, at least for a while, economic policy makers will need to
suspend what are usually sacred principles: minimal interference in
free markets, gradualism and predictability.

In the last month, both the Treasury and the Fed took extraordinary
steps toward nationalizing three of the biggest financial companies in
the country. Last month, the Treasury took over Fannie Mae and Freddie Mac,
the giant government-sponsored mortgage-finance companies that were on
the brink of collapse. A week later, the Fed took control of the American International Group, the failing insurance conglomerate, in exchange for agreeing to lend it $85 billion.

On Wednesday, the Federal Reserve announced that it would lend A.I.G. an additional $37.8 billion.

But neither the individual corporate bailouts nor the Fed's enormous
emergency lending programs - including up to $900 billion through its
Term Auction Facility for banks - have succeeded in jump-starting the
credit markets.

"The core problem is that the smart people are realizing that the
banking system is broken," said Carl B. Weinberg, chief economist at
High Frequency Economics. "Nobody knows who is holding the tainted
assets, how much they have and how it affects their balance sheets. So
nobody is willing to believe that anybody else isn't insolvent, until
it's proven otherwise."

 

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