Bailout becomes buy-in as US Feds move into banking

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(Agencies)
Updated: 2008-10-15 06:59

WASHINGTON -- Big banks started falling in line Tuesday behind a rejiggered bailout plan that will have the US government forking over as much as $250 billion in exchange for partial ownership -- putting the world's bastion of capitalism and free markets squarely in the banking business.

Some early signs were hopeful for the latest in a flurry of radical efforts to save the nation's financial system: Credit was a bit easier to come by. And stocks were down but not alarmingly so after Monday's stratospheric leap.

The new plan, President Bush declared, is "not intended to take over the free market but to preserve it."

US President George W. Bush makes a statement on the economy in the Rose Garden of the White House, following a meeting of his working group on financial markets in Washington October 14, 2008. [Agencies]

It's all about cash and confidence and convincing banks to lend money more freely again. Those are all critical ingredients to getting financial markets to function more normally and reviving the economy.

The big question: Will it work?

There was a mix of hope and skepticism on that front. Unprecedented steps recently taken -- including hefty interest rate reductions by the Federal Reserve and other major central banks in a coordinated assault just last week -- have failed to break through the credit clog and the panicky mind-set gripping investors on Wall Street and around the globe.

The Dow Jones industrials declined 77 points on Tuesday after piling up their biggest point gain ever on Monday on news of Europe's rescue plan and in anticipation of the United States' new measures.

Initially the US government will pour $125 billion into nine major banks with the hope that they will use the money to rebuild their reserves and to increase lending to consumers and businesses. Another $125 billion will be made available this year to other banks -- if they need it -- for cash infusions.

In return, the government will get ownership stakes in the financial institutions. Banks, meanwhile, will have to accept limitations on executives' compensation.

"Government owning a stake in any private US company is objectionable to most Americans -- me included," Treasury Secretary Henry Paulson said in announcing the initiative. "Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable."

Whether the $250 billion will be sufficient to encourage banks to lend again is hard to tell, said Anil Kashyap, professor of economics and finance at the University of Chicago's Graduate School of Business. The Treasury Department arrived at the $250 billion figure after consulting with banking regulators.

"This plan will work if we wind up with everybody pretty well capitalized," Kashyap said. "But if it doesn't reach that point, we'll be back in soup down the road."

The government is counting on banks not to just clutch onto the cash, which aggravated the credit crisis to begin with.

"The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it," Paulson said.

Treasury switched gears deciding to first use a chunk of the $700 billion from the recently enacted financial bailout package to pay for taking partial ownership stakes in banks, rather than using the money to buy rotten debts from financial institutions. The government said it still intends to buy the bad mortgages and other toxic assets, another move aimed at getting credit flowing again.

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