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WORLD> America
Bailout becomes buy-in as US Feds move into banking
(Agencies)
Updated: 2008-10-15 06:59

Besides the $250 billion this year on the stock purchases, Bush said Tuesday that an additional $100 billion would be needed in connection with covering bad assets. That would leave $350 billion of the $700 billion program, presumably to be spent by the next president.

Economists as well as both Democratic and Republican lawmakers on Capitol Hill had urged Treasury to first move forward on the capital injection plan, arguing that was a more effective way to battle the financial crisis.

The first bank to take advantage of the program was Bank of New York Mellon which announced it would sell $3 billion in preferred shares to the Treasury. Other banks initially participating include Goldman Sachs Group Inc., Morgan Stanley, JPMorgan Chase, Bank of America Corp., including the soon-to-acquired Merrill Lynch, Citigroup Inc., Wells Fargo & Co., and State Street Corp.


US Treasury Secretary Henry Paulson announces that the Treasury Department will take equity stakes in potentially thousands of banks totaling about $250 billion at the Treasury Department Cash Room in Washington, October 14, 2008. Standing beside Paulson are Federal Reserve Chairman Ben Bernanke (C) and FDIC Chairman Sheila Bair. [Agencies]

The government's cash infusions are attractive to banks because they are having trouble getting money from elsewhere. Skittish investors have cut them off, moving their money into safer Treasury securities. Financial institutions are hoarding whatever cash they have rather than lending it to each other or customers.

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Two other initiative also were unveiled to stem the credit crisis: The Federal Deposit Insurance Corp. launched an insurance fund to temporarily guarantee new issues of bank debt -- fully protecting the money even if the institution fails.

And, the FDIC will start providing unlimited deposit insurance for non-interest bearing accounts, which are mainly used by businesses to cover payrolls and other expenses. Frequently these accounts exceed the current $250,000 insurance limit, so the expanded insurance should discourage nervous companies from pulling their money out. Both of these efforts would be financed by fees charged to participating financial institutions -- not money from the bailout package.

Even if the new plan works, economists caution that it could take years before locked up lending returns to normal.

The difference between the rate at which banks lend to other banks and the rate at which they buy US government debt has narrowed, but remains near a 25-year high — a glaring sign that there's still fear in the market. But there was a hopeful glimmer elsewhere: A crucial short-term, bank-to-bank lending rate called the London Interbank Offered Rate, or Libor, inched down Tuesday. That rate is important because a lot of commercial loans and many adjustable-rate mortgages are tied to it.

Some of the banks had to be pressured to participate by Paulson, who wanted healthy institutions to go first as a way of removing any stigma that might be associated with banks getting bailouts. Paulson met privately with bank executives on Monday.

The government's shares will carry a 5 percent annual dividend that will increase to 9 percent after five years. That increase in the rate is aimed at providing an incentive for companies to buy the government out. The advantage to the taxpayer is that if the rescue plan works, then the shares can be sold for more than the government initially paid, providing a profit on the transaction.

The move, in effect a partial nationalization of the banking system, does put the United States in the awkward position of owning shares in institutions it also regulates. The shares purchased by the government will be nonvoting. They also give the government a priority in getting paid back if a company fails.

So far this year, 15 banks have failed, compared with three for all of 2007.

"The government's role will be limited and temporary," Bush pledged. "These measures are not intended to take over the free market but to preserve it."

At a news conference last month, Bush defended his administration's increasingly aggressive market interventions to deal with the worst financial crisis in more than a half-century.

"I'm sure there are some of my friends out there saying, I thought this guy was a market guy; what happened to him? Well, my first instinct wasn't to lay out a huge government plan. My first instinct was to let the market work until I realized, upon being briefed by the experts, of how significant this problem became," Bush said then.

The Federal Reserve, meanwhile, announced that it will begin buying vast amounts of short-term debt on Oct. 27 -- its latest effort to break through a credit clog. The Fed is invoking Depression-era emergency powers to buy commercial paper -- a crucial short-term funding that many companies rely on to pay their workers and buy supplies. Last week the Fed said it intended to take the action but didn't specify when.

The economy's problems also are taking their toll on the government's coffers. The 2008 budget deficit hit an all-time high of $454.8 billion. The red ink probably will be a lot worse next year as the costs of the government's rescue of the financial system and the economic hard times clobber the federal balance sheet, economists predict.

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