[R-G] U.S. May Take Ownership Stake in Banks

[Yoshie Furuhashi]

<http://www.nytimes.com/2008/10/09/business/economy/09econ.html>
October 9, 2008
U.S. May Take Ownership Stake in Banks
By EDMUND L. ANDREWS and MARK LANDLER

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, still preliminary, 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."