The Bush administration's financial rescue plan Version 2.0 marks an abrupt change in the government's approach toward banks and the use of taxpayers' money. Here are some answers to questions about these changes:
Q. What does this mean for my bank?
The goal is to help banks attract more money so they can resume lending. Without lending, the economy becomes paralyzed.
Q. Is this free money for the banks?
No. For starters, some of the nine banks didn't welcome this infusion but were told it was necessary to level the playing field.
“We didn't need it, but we understood the wider need,” said Bob Stickler, a spokesman for Bank of America in Charlotte. He added, “The banks in general were not given a choice. The government felt like they wanted everybody to be in on it.”
The government also will get a 5 percent dividend on its stakes for the first five years, rising to 9 percent if the government owns shares longer than that. There also are a number of restrictions on CEO perks for companies that get this infusion.
Q. What if the banks sit on this money?
Good question; that's kind of what's happened with the $800billion in short-term emergency loans that the Federal Reserve has pumped into the banking system in recent months. The government hopes to lead by example, sending a message that with a government stake, a given bank is a safe partner to which other banks can lend.
Q. But how will government know if banks are lending again?
There are indicators of what's happening in credit markets, such as the London Interbank Offered Rate, or Libor, for loans between banks. If the Libor declines, the rescue plan is working. Another indicator is what happens in the market for credit default swaps, complicated insurance products whose interest rate falls as risk is perceived to be abating.
Q. Will the government now influence who gets loans and on what terms?
FDIC Chairman Sheila Bair said regulators are working on devising some sort of yardstick for measuring how this capital infusion is translating into lending. But any yardstick points to the slippery slope of government involvement in commerce. Free market theory holds that markets allocate capital to its most efficient use. If government dictates how lending happens, or chooses to whom money is lent, it distorts decision-making. The risk is that government could encourage poor lending decisions.
Q. What about small businesses?
Companies that have noninterest paying accounts whose balances exceed $250,000 will get temporary, unlimited insurance from the FDIC. It's free for 30 days. Unless they opt out, the FDIC will then charge a premium of 10 cents on every $100 in deposits above $250,000 for this insurance. This is in the plan because smaller banks were losing customers to big national banks.