Morning in America: Buying Bank Stock Ends Reagan Era

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McClatchy Newspapers

Morning in America: Buying Bank Stock Ends Reagan Era

by
Kevin G. Hall

WASHINGTON - When the sun set on the nation's capital Tuesday, it marked the end of one era in the nation's political economy and the beginning of another. American taxpayers, the proverbial Joe Six-Pack and Jane Wine-Box of campaign lore, had become partial owners of the nation's nine leading banks, with more to come.

The Bush administration's announcement that it would take ownership stakes in private banks marked a momentous shift away from a 30-year effort to get government out of business's way and opened the door to a new era of government engagement with business in ways that are only starting to unfold.

Although it's a move toward socialism, it's far short of nationalization. While government is now to be a partial owner of banks, it isn't taking over their management. The joint ownership is expected to be temporary, perhaps three to five years, and once the banks regain stability and profitability, the government intends to sell its shares in the hope of earning taxpayers a profit.

Rather than a wholesale switch from free-market capitalism to socialism, then, what's going on here is instead a progression of the mixed democracy-capitalism that's been evolving at least since Franklin D. Roosevelt's New Deal of the 1930s. The evolution this time is toward stronger government and more regulated markets, whereas since the start of the Reagan Revolution in 1981, it's been the opposite.

Now government and bankers will be limited partners - and strange bedfellows.

On Tuesday, the Bush administration tapped big financial players to oversee the rescue of their own industry. Pacific Investment Management Co., the world's biggest bond fund, was chosen to administer the Federal Reserve's new lending to corporate America, which will bypass banks.

Bank of New York Mellon, one of the institutions in which the government will take an equity stake, was selected as the custodian for the purchase of distressed assets from banks, and will evaluate the quality of these assets and set their prices.

When the federal government seized savings and loans in the 1980s or when it took bank stakes during the Great Depression of the 1930s, it did so because they were insolvent. Tuesday's partial bank purchases were instead an attempt to thaw credit markets that had frozen amid a loss of confidence in lending of all sorts. It was a bid to change market psychology.

"Today's actions are not what we ever wanted to do, but today's actions are what we must do to restore confidence to our financial system," Treasury Secretary Henry Paulson said in announcing plans to invest $125 billion in nine U.S. banks: Bank of America, including Merrill Lynch separately, as well as Citigroup, Bank of New York Mellon, Goldman Sachs, J.P. Morgan Chase, Morgan Stanley, State Street and Wells Fargo.

The Treasury will buy $25 billion in preferred stock in Bank of America - including Merrill Lynch - as well as J.P. Morgan and Citigroup; $20 billion to $25 billion in Wells Fargo; $10 billion in Goldman and Morgan Stanley; $3 billion in Bank of New York Mellon; and about $2 billion in State Street.

Paulson set aside another $125 billion to invest in hundreds, perhaps thousands, of other banks through mid-November. All told, more than a third of the $700 billion that Congress authorized weeks ago to purchase distressed assets from banks now will be used to give banks the equivalent of a flu shot against a nasty financial virus.

Will it work?

The verdict on the Bush plan will be visible first in what happens in coming weeks to obscure indicators such as overseas rates for lending in dollars and the spread, or gap, between these rates and those for safe investments, led by Treasury bonds. But the real measure of success will be how fast banks resume lending and businesses return to vitality. Most economists think that the United States is in a recession; the question is how deep and how long it will be. The answer probably won't be known before spring.

"More timely action would have been better, but it is now coming and in international coordination - a plus," said R. Glenn Hubbard, the dean of Columbia University's Graduate School of Business and the chairman of President Bush's Council of Economic Advisers from 2001 to 2003.

After posting record percentage-point gains Monday, U.S. stocks opened strong on the news, then turned negative. The Dow Jones Industrial Average closed down 76.62 points to 9310.99, while the S&P 500 was off 5.32 points to 998.01. The Nasdaq fished off 65.24 points to 1779.01.

That wasn't necessarily a bad thing; it was the first day in weeks that didn't see wild swings. If volatility ebbs, traders can focus on economic and business fundamentals again.

The new Bush plan won't give taxpayers a controlling stake or voting rights in affected banks, nor any apparent way to influence the makeup of a bank's board of directors. But participating banks must curtail executive bonuses and other perks, and performance-based pay must be forfeited if a bank's accounting is found later to have inflated the numbers.

"This is the first time in American history that the federal government has applied restrictions on the compensation that goes to top executives," Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee, said in a statement.

There were other important firsts.

The Federal Reserve on Tuesday set a date of Oct. 27 to begin bypassing banks and lending directly to U.S.-based corporations in an effort to keep the American financial system afloat. This effort, announced earlier, is a milestone because the Fed will lend to institutions that aren't banks and are outside its regulatory reach.

It will lend to big corporations such as General Electric, AT&T and Caterpillar that fund their short-term needs by issuing bond-like promissory notes called commercial paper. Investment banks and institutional investors traditionally buy this paper, but the credit crunch has caused this vital market to seize up. Enter the Fed. It will temporarily buy top-rated three-month commercial paper in an attempt to crack this frozen market.

In a similarly novel move, the Federal Deposit Insurance Corp. unveiled a three-year program to provide insurance for interbank loans, the short-term loans that banks give one another. They're essential to the functioning of the U.S. financial system.

The FDIC will insure up to $1.4 trillion worth of these loans, mostly through premiums charged on these transactions. The FDIC temporarily has unlimited borrowing authority, with the Treasury to handle whatever the crisis brings next.

The FDIC also said it would begin insuring non-interest-bearing bank accounts whose deposits exceed $250,000. The move will help small businesses that depend on these accounts, which often exceed normal deposit-insurance limits, for cash flow and payroll. The FDIC thinks that the sum of these accounts nationwide is $400 billion to $500 billion. To pay for the expanded insurance, depositors will be charged an extra dime on every $100 deposited above $250,000.

In an interview with a group of reporters, FDIC Chairman Sheila Bair explained that smaller banks were beginning to see an exodus of business deposits to larger institutions on fears that the FDIC wasn't insuring these accounts. That was leaving the small banks with insufficient deposits to make new loans.

Bair acknowledged that if this had been the original plan sought from Congress, the big Charlotte, N.C.-based commercial bank Wachovia, which recently was forced to sell itself to rival Wells Fargo, might still be a standalone bank.

"It definitely would have made a difference," she said, adding that Washington Mutual, the nation's largest thrift, which went bust last month, wouldn't have been spared if the government had moved earlier to take equity stakes in lenders.

She described Tuesday's action as unprecedented, as the FDIC was forced to move because of problems outside the sector it regulates.

"I think it is apparent that the major failures and stress have been outside the banking system. The bigger danger to the banks is the economic situation," Bair said; that's why it's vital to gird the banking sector for the coming economic slowdown. "We are the core, the heart of the financial system of the economy, and we need to put banks in a stable place."

 

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