Feds' bank plan stirs anxiety

The federal government's decision to buy ownership stakes in U.S. banks has helped ease the flow of credit, but some analysts worry the massive intervention will inject politics into the financial system and sow the seeds of another crisis in the long run.

This week, the government plans to make stock purchases of nine major banks, including Charlotte-based Bank of America Corp. and San Francisco-based Wells Fargo & Co., which is buying Charlotte-based Wachovia Corp. The deals are designed to bolster the banks' balance sheets so they will begin more normal lending.

The action will mark the first deployment of resources from the government's $700 billion financial rescue package passed by Congress on Oct. 3.

The danger comes if lawmakers and policy makers employ the government's ownership stake in banks to pursue social agendas, analysts said. Such interference from officials contributed to the federal takeover of mortgage giants Fannie Mae and Freddie Mac, private companies created by Congress to buy and guarantee mortgages.

Fannie and Freddie came under pressure from lawmakers and policy makers to lend widely to increase homeownership, analysts said. As a result, Freddie and Fannie bought and guaranteed risky mortgages, which generated huge losses and compelled the government to step in.

With the Treasury now taking ownership stakes in private banks, “you are potentially making more Freddies and Fannies,” said Vincent Reinhart, resident scholar at the American Enterprise Institute, a Washington think tank. “The question is, will politicians refrain from using the new influences these actions have given them?”

Treasury Secretary Henry Paulson this month launched an initiative to shore up the financial system by investing $250 billion directly in U.S. banks, providing the capital they need to weather the financial crisis. The government has not intervened on such a scale since the Great Depression, when federal programs such as the Reconstruction Finance Corp. lent to and invested directly in banks and other companies.

In theory, the government will become a silent partner under Paulson's scheme, taking nonvoting preferred shares and letting bankers run their banks. Among the dangers of having government in the role of partner, silent or otherwise, are potential conflicts of interest, said analysts. Another big question is the exit strategy: How will the government get out of the banking business?

The design of the rescue program suggests banks would buy out the government within five years, before the dividends banks must pay to the government nearly double. In the first five years, banks pay the government a 5 percent dividend; after five years it jumps to 9 percent.

Both Paulson and President Bush have said these are short-term investments the government will sell as soon as the financial system returns to normal.

The fear is that political considerations could override such intentions. Already, the mortgage industry has been essentially nationalized, with the Freddie and Fannie takeovers and the expanded role of federal housing agencies in making loans, said Mark Zandi, chief economist of Moody's It might become difficult for the government to end its support of banks if higher interest rates for loans would result, he said.

“The government is now so deeply into the financial system,” said Zandi, “it's not clear how it's going to get out of the business.”

At the least, it could take a long time. The Swedish government bailed out its banking system in the early 1990s, and still holds a significant stake in one major bank. In the United States, the Depression-era Reconstruction Finance Corp. operated into the 1950s.

In addition, having the security of government backing could encourage banks to take unwise risks.

“If it becomes clear to banks that the government will come to their rescue,” said Nariman Behravesh, chief economist of forecasting firm Global Insight, “they will behave as if there's no downside risk.”

But Ricardo Caballero, an economics professor at MIT, said effective regulation could prevent such risky behavior. Caballero said the government had to prevent a collapse of the financial system, and probably should have launched the bailout sooner. The Associated Press contributed.