U.S. May Take Ownership Stake in Banks
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 was still preliminary and it was unclear how the process would work, but it appeared that it would be voluntary for banks.
The proposal 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.
On Thursday, shares rebounded somewhat in Europe, with many exchanges up more than one percent, but Asian markets were mixed.
The gloomy market response on Monday 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.”
October 9, 2008, 6:53 am
Doing the right thing?
A tentative cheer: Paulson may have been dragged kicking and screaming into doing the right thing to rescue the financial system:
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.
Let’s give thanks to Chris Dodd, who insisted on the provision that makes this possible — and to Gordon Brown, for showing the way.
Update: Nouriel Roubini has some of the back story on how the TARP came to include provisions that could be used to recapitalize banks. From early on, there was indeed a feverish push by a number of economists, myself included, to get some channel for public capital injections in return for equity stakes into the plan. I reluctantly called for passage of the final bill because it did include such a channel, although it didn’t require that Paulson use it. There were a lot of accusations against those of us who took that position — claims that we were caving in, or trying to have it both ways. But the equity issue was crucial — and may now be the thing that turns a useless plan into something that really does a lot of good.
Asian Markets Stabilize After Global Rate Cuts
By Blaine Harden
Washington Post Foreign Service
Thursday, October 9, 2008; 11:00 AM
SEOUL, Oct. 9 -- Stock markets in Asia stabilized Thursday, as interest-rate cuts across the region helped ease investor fear.
Europe was also trading higher early in the day but retrenched somewhat in the afternoon with many of the major indexes trading up around 1 percent.
Following an orchestrated rate cut in the United States and Europe, the central banks of China, South Korea, Taiwan and Hong Kong all reduced the cost of borrowed money. China lowered its one-year rate Wednesday night, while South Korea, Taiwan and Hong Kong all acted Thursday morning.
The effect on stock markets in Asia was to replace a five-day downward spiral of panic, fear and fast-disappearing wealth with a relatively quiet day of relief.
Japan's benchmark Nikkei average, which plunged nearly 10 percent on Wednesday, ended the day off by 0.5 percent, as political officials debated whether they should pursue new public spending projects to stimulate an economy buffeted by the drop in world auto sales.
Elsewhere in the region, Hong Kong's Hang Seng index gained 3.31 percent, while South Korea's Kospi Index rose 0.6 percent.
South Korea's currency has lost a third of its value against the dollar this year, prompting President Lee Myung-bak to warn Wednesday that currency speculators must stop "greedily pursuing private interests" when their nation is in trouble.
While the Nikkei ended slightly down overall, some buyers were attracted into the market by the low prices for blue-chip stocks. Nippon Steel, Japan's largest steel company, was up more than 6 percent, after falling 12 percent Wednesday. Shares in Toyota Motor also rebounded, but not very much. They were up about 1 percent, after falling 11 percent the day before.
Fear and a worsening economic outlook had pushed indexes from Mumbai to Saudi Arabia to London down sharply Wednesday before central banks around the world orchestrated the interest-rate cut. European markets rebounded slightly later in the day before falling again.
Regulators in Indonesia and Russia halted trading Wednesday after declines of more than 10 percent. Mumbai's Sensex index plunged nearly 6 percent when markets opened, then staged a partial recovery. Markets also fell in Persian Gulf countries, frustrating banking officials there who said economic indicators in the region remain solid.
But Thursday, European markets were higher by between 1 and 2 percent, with financial stocks in London enjoying double digit gains after the government there said it would invest $88 billion into the country's biggest banks. Shares in those banks, including HBOS and the Royal Bank of Scotland, were heading for strong double-digit gains.
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