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OCTOBER 14, 2008
.U.S. to Buy Stakes in Nation's Largest Banks
Recipients Include Citi, Bank of America, Goldman; Government Pressures All to Accept Money as Part of Broadened Rescue EffortBy DEBORAH SOLOMON, DAMIAN PALETTA, MICHAEL M. PHILLIPS and JON HILSENRATH.Article
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more in Economy ».WASHINGTON -- The Bush administration is expected to take stakes in the nation's top financial institutions as part of a wide-ranging effort to restore confidence to the battered banking system, following similar moves by European governments that sent global stock markets soaring.


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Morgan Stanley CEO John Mack (L) and Citigroup CEO Vikram Pandit leave a meeting at the Treasury Department.
.As part of its new plan, the government is set to buy preferred equity stakes in nine top financial institutions, according to people familiar with the situation. It's unclear how much would be invested in each institution. The move is designed to remove any stigma that might come with a government investment.

Banks receiving government funds include Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and Bank of New York Mellon.

Not all of the banks involved are happy with the move, but agreed under pressure from the government.

The new plan is designed to bolster bank balance sheets by providing new capital, removing rotten assets and taking new steps to make sure they have access to the funds they use to operate. All told, the moves are designed to get money flowing through the system so that banks will lend to companies, consumers and each other.

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.The initiatives, which will likely supersede many of the government's previous efforts, ensure that the U.S. banking sector will be tied to the federal government for years to come. They are being formulated jointly by the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp.

One central plank of these new efforts is a plan for the Treasury to take approximately $250 billion in equity stakes in potentially thousands of banks, according to people familiar with the matter, using funds approved by Congress through the $700 billion bailout bill.

In addition, the FDIC is expected to temporarily extend its guarantee of bank deposits to include certain new funds raised by banks and thrifts for three years. That would be an aid to lenders that have had a hard time raising capital without government assistance.

Other moves could include temporary loan guarantees aimed at helping banks borrow the money they need to do business. Officials are still working through how such a plan would work.

All told, the program would put the guarantee of the government behind much of the plumbing of American financial markets, a step that would have appeared inconceivable a few months ago. But the seizure in credit markets and last week's plunging stock markets forced policy makers around the world to shift gears.

Monday, the big European powers -- the U.K., Germany, France, Spain and Italy -- provided further details of measures to buy stakes in struggling banks and offer lending guarantees. The U.K., which first formulated this plan, is planning to issue some £37 billion ($63.1 billion) in new government debt to pay for purchases of the common and preferred shares of three big banks. The U.K. will also guarantee some £250 billion in bank debts with maturities of up to three years. The guarantees extend to the vast and frozen market for interbank lending, or short-term loans made among banks, a U.K. Treasury spokeswoman said.

The current planning in Washington would bring the U.S. in line with these countries.

Treasury Secretary Henry Paulson has grown increasingly concerned about the worsening situation and wants to aim government dollars directly at bank balance sheets.

Details are still being finalized, but the equity-injection program is expected to be open to almost all banks, with a focus on getting the participation of the most important firms to financial system, according to people familiar with the matter.

While the Treasury wants to put money into banks, its main goal is to attract private capital. To make sure private investors aren't scared away, the Treasury is expected to structure its investment on terms favorable to the banks and will inject capital in exchange for preferred shares or warrants, these people said, a move that is designed to not hurt existing shareholders.

“These are tough times for our economies. Yet we can be confident that we can work our way through these challenges.
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President Bush in a joint statement with Prime Minister Berlusconi of Italy

Mr. Paulson called top U.S. banking heads to a meeting Monday in Washington, people familiar with the matter said. Expected to attend were executives including Ken Lewis, CEO of Bank of America; Jamie Dimon, CEO of J.P. Morgan Chase; Lloyd Blankfein, CEO of Goldman Sachs Group; John Mack, CEO of Morgan Stanley; Vikram Pandit, CEO of Citigroup; and Robert P. Kelly, CEO of Bank of New York Mellon.

Federal Reserve Bank of New York President Timothy Geithner remained in Washington Monday after spending part of Sunday huddled with senior officials at the Treasury Department to work out the latest plan.

The government's new focus is already raising questions about why it didn't adopt such an approach sooner. Mr. Paulson actively opposed the idea that the government should directly invest in banks because he worried about picking winners and losers. He was also concerned banks wouldn't participate because of the perceived stigma and the potential for the government to meddle in their affairs, according to people familiar with the matter.

Instead, Treasury has marched ahead with a plan to buy distressed assets directly from banks.

House Democratic leaders, including Speaker Nancy Pelosi (D., Calif.) and House Financial Services Committee Chairman Barney Frank, held a closed-door session Monday with 11 economists and other advisers, including Nobel laureate Joseph Stiglitz, to discuss the financial crisis. The group threw its weight behind Treasury's decision to inject capital into the banking system, in exchange for equity stakes.

"The consensus was so strong towards direct equity injections that there was literally no dissension on the point," said one of the invited economists, Jared Bernstein of the liberal Economic Policy Institute. "The only head-scratching is why did it take us so long to get here?"

Officials at the Treasury and Federal Reserve have been looking for a comprehensive approach to the credit crisis after a series of ad hoc interventions and decisions. The government's various moves, from saving mortgage giants Fannie Mae and Freddie Mac to letting Lehman Brothers Holdings Inc. fail, have confused investors and frozen many in place at a time when the banking system was desperate for fresh capital. That contributed to what in essence was a high-level run on Wall Street banks, with funding drying up overnight and customers pulling away business.

The government's hope is that the new plan will more thoroughly address the problems of ailing financial institutions -- relating to their assets, liabilities and equity -- and will also persuade private investors that government involvement won't come at their expense.

For troubled assets there is the TARP program, created by the $700 billion bailout bill, which gives the Treasury Department authority to acquire bad assets from banks and other financial institutions. The TARP program will also be used by Treasury when it puts new equity into banks.

The other steps, including the FDIC's role in guaranteeing new funds raised by banks and thrifts, is designed to address the way banks fund themselves, freeing them to start lending again.

Many kinds of bank borrowing remain highly strained, most notably the short-term loans that banks make to each other to finance their day-to-day operations, known as interbank lending. This market is especially important, because it produces closely followed interest rates. The London interbank offered rate, or Libor, is a benchmark for many U.S. consumer and business loans.

"The guarantee means the debt holders don't run," said Anil Kashyap, a University of Chicago Business School economist.

William Poole, former president of the Federal Reserve Bank of St. Louis, was a fierce critic of Treasury's initial plan to buy up distressed mortgage-backed securities. Such a scheme, he said, would lead banks to dump their worst assets on the taxpayers.

But Treasury's new tack may well do the trick, said Mr. Poole, now a senior fellow at the free-market-oriented Cato Institute.

"Investors need to be confident that the banks they're dealing with are unquestionably solvent, and it's in the interest of banks to assure investors that that's the case," Mr. Poole said. "One way banks can provide that assurance is to raise additional capital, in some combination of private and government capital."

Dean Baker, co-director of the left-of-center Center for Economic and Policy Research, said that the Treasury emphasis on recapitalization "makes an awful lot more sense" than the asset-purchase plan.

He argues that the country may have turned a corner on the financial panic -- the fear that has kept banks and investors from making even the most prudent loans. "I think we're through the worst on that," Mr. Baker said. "Maybe I'll be proven wrong, but it really was at an extreme last week."