The U.S. government is dramatically escalating its response to the financial crisis by planning to invest $250 billion in the country's banks, leading nine of the largest to accept a Treasury stake in what amounts to a partial nationalization.
The Treasury Department's decision to take equity stakes in banks represents a significant reversal, coming just weeks after Treasury Secretary Henry Paulson had opposed the idea.
The Wall Street Journal reported the government will buy $25billion in preferred stock in Bank of America – including Merrill Lynch – as well as JPMorgan Chase and Citigroup; between $20billion and $25 billion in Wells Fargo, which is acquiring Wach ovia; $10billion in Goldman Sachs and Morgan Stanley; $3billion in Bank of New York Mellon; and about $2 billion in State Street.
In the momentous meeting Monday in Washington, Paulson, flanked by top financial regulators, told executives of the banks that they needed to participate in the program for the good of the national economy, two industry sources said on condition of anonymity.
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The government's initiative, which is to be announced this morning before the markets opened for New York trading, is part of a wider plan that goes beyond the $700 billion rescue package approved by Congress earlier this month.
The Federal Deposit Insurance Corp. is also set to announce today the launch of an insurance fund to guarantee new issues of bank debt. It will provide unlimited deposit insurance for non-interest bearing accounts, which are widely used by small businesses for payroll and other purposes.
In pressing the bank executives to accept partial government ownership, Paulson's message was clear: Though officially the program was voluntary, the banks had little choice in the matter.
“We're a healthy bank,” Bank of America spokesman Bob Stickler told the Observer on Monday night. “We just raised $9 billion in capital on our own and are operating quite normally. However, we recognize what's going on in the financial system and need to be part of the solution. So we're happy to participate in this program.”
In addition to the first group of banks, the government would make another $125 billion available for the next 30 days to thousands of other U.S. banks and thrifts.
Federal officials set conditions, telling the banks they could not raise their dividends without government permission and could not offer their executives new retirement packages, though the old packages would remain intact.
Paulson told them the moves would shore up confidence in their own institutions, spark lending throughout the system and send a message to smaller institutions that there is no stigma in accepting federal funding. Some were reluctant, but all of the executives complied.
There is a risk banks will take the new government capital and use it to bolster their balance sheets but still not resume lending, and the Treasury is not getting any specific contractual guarantee to prevent that from happening. But bank regulators, particularly the Federal Reserve, will lean heavily on the firms receiving infusions to use the capital to increase their lending to businesses and consumers.
Taken together, the steps planned by the Treasury, the FDIC and the Fed amount to a monumental effort to jump-start the business of lending, which all but dried up in recent weeks as banks have lost faith in one another and their customers. Global markets began to melt down. Some emerging nations teetered on the brink of financial collapse.
Over the weekend, global leaders agreed in meetings in Washington to launch a coordinated program of injecting cash into the world's banks and guaranteeing their debt. The action by U.S. officials Monday represented the U.S. version of those broad principles, and it was matched by similar efforts in Europe on Monday.
As part of the effort to flood the financial system with cash, the Federal Reserve made unlimited funds available early Monday to other major central banks so they could inject money into their own banks and ease the shortage of dollars they face. Previously, the Fed's program of lending dollars to the European Central Bank, Bank of England, Bank of Japan and others had been capped at a total of $380 billion.
Under the rescue legislation signed in law earlier this month, the Treasury is allowed to take equity stakes in banks.
During debates on Capitol Hill, Paulson repeatedly described that measure as a way to shore up ailing financial institutions by buying their troubled mortgage securities and other assets.
Now that he has decided to use the $250 billion installment to pump capital directly into the banking system, he is planning to immediately ask Congress for a second installment of $100 billion to buy or insure the assets from institutions, according to congressional staff and banking industry executives briefed on the plan.
“When I was talking to members of Congress back then, they believed they were voting to buy up troubled assets, not to make capital infusions in banks,” said Alan Blinder, a Princeton economist and a former Fed vice chairman. “If I were a member of Congress, I would be wondering about bait and switch because that was not really discussed.”