U.S. Treasury To Follow Europe, Invest In Banks

President Bush announced plans Tuesday to pump billions of dollars in new capital into U.S. banks. The package follows similar steps by European governments announced Monday. In both cases, the moves will deepen government roles in the economy.

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RENEE MONTAGNE, host:

This is Morning Edition from NPR News. I'm Renee Montagne. President Bush announced earlier this morning that the government will pump billions of new capital into U.S. banks, money that's part of the $700 billion rescue plan. The aim is to make the banks stronger financially and - just as important - restore investor confidence. The U.S. plan is similar to what European governments announced yesterday. In both cases, the moves will expand government roles in the economy. In response, stock markets from Tokyo to London are soaring. From Frankfurt, Germany, NPR's Tom Gjelten reports.

TOM GJELTEN: The global financial crisis has sorely tested the faith of devoted free marketeers. In recent weeks, the stock and credit markets have appeared to be so irrational in their behavior that even conservative governments have concluded they have no choice but to intervene for the good of the world economy. German Chancellor Angela Merkel grew up in communist East Germany and is deeply suspicious of socialism. But in announcing her government's financial rescue plan yesterday, she hardly sounded doctrinaire.

Chancellor ANGELA MERKEL (Germany): (German spoken)

GJELTEN: We've had to deal with the excesses of the market, Merkel said. In a social market economy, the duty of the state is to have control. The state is the guardian of order. Germany and other European states are intervening in their economy in two ways, first by guaranteeing loans that banks make to each other. If one bank fails to repay another bank, their governments can step in to cover the loan. Across Europe, governments are pledging about a trillion dollars for those loan guarantees. But governments are also injecting billions of dollars in fresh capital directly into troubled banks. Thorsten Polleit is chief economist at Barclays Capital in Frankfurt.

Dr. THORSTEN POLLEIT (Chief Economist, Barclays Capital, Frankfurt): The problem is confidence is gone. And confidence is gone because many investors expect banks running into big losses which may even exceed their capital base.

GJELTEN: So the governments with cash infusions increase the banks' capital base and then...

Dr. POLLEIT: Investors might find some confidence in extending loans and deposits into banks again.

GJELTEN: The logic is sound, Polleit says, but he also worries that this unprecedented government action could carry some risk.

Dr. POLLEIT: Whenever we have government interference, we have to take into account the law of unintended consequences. I'm a bit concerned that all this interference into market processes could actually make the situation worse.

GJELTEN: In both the United States and Europe, governments are now taking responsibility for some bad debts and shaky banks. The assumption is that the governments can handle those obligations, but the cost is hard to calculate. Herman Brodie is a financial risk analyst at Cognitrend in Frankfurt.

Mr. HERMAN BRODIE (Managing Director, Cognitrend, Frankfurt): This is a step in the right direction. But of course the more risk the governments take on themselves and take it away from the financial system, the more their own creditworthiness is going to be called into difficulty. If you look in the financial markets this morning, you'll see bond prices are lower, and this is a reflection of the risks that governments are now taking onboard.

GJELTEN: Bond prices are lower in part because stocks are more popular at the moment, but it's also because government IOUs are a bit less attractive when a government is loading itself down with major financial obligations. Those obligations are also likely to mean higher interest rates down the road and less money to spend on other social and economic needs. Still, it's hard at the moment to see any alternative to the new government role. German Finance Minister Peer Steinbrueck, speaking with Chancellor Merkel yesterday, said his government is just looking out for the interests of its population.

Mr. PEER STEINBRUECK (German Finance Minister): (German spoken)

GJELTEN: A stable and functioning financial sector is important to the citizens and to this country, Steinbrueck said. It's important for the middle class saving for retirement and for those communities that need loans to finance infrastructure investments. We're talking about a public good which we need to protect. Tom Gjelten, NPR News, Frankfurt.

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U.S. Investing In Banks To Free Up Lending

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke i i

Treasury Secretary Henry Paulson (left) speaks while Federal Reserve Chairman Ben Bernanke listens during a Tuesday news conference to outline a new government plan to stabilize U.S. banks by investing in them. Mark Wilson/Getty Images hide caption

itoggle caption Mark Wilson/Getty Images
Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke

Treasury Secretary Henry Paulson (left) speaks while Federal Reserve Chairman Ben Bernanke listens during a Tuesday news conference to outline a new government plan to stabilize U.S. banks by investing in them.

Mark Wilson/Getty Images

The Bush administration's latest prescription for the ailing financial industry — a program that clears the way for the U.S. government to buy a $250 billion equity stake in the nation's banks — provided only the slightest glimmer of optimism in the U.S. financial markets Tuesday.

The Dow Jones industrial average rose nearly 400 points at the opening bell but ended the day 76.62 points lower, at 9310.99. Investors bid down stocks as they braced for what comes next: the bite the financial crisis is bound to take out of corporate profits.

On Tuesday morning, President Bush and Treasury Secretary Henry Paulson were careful to tiptoe around the idea that with the program they were nationalizing the nation's banks. Instead, they preferred to cast their decision to spend about a third of the $700 billion Congress provided as a "recapitalization" effort. The president said the decision to buy shares in the nation's leading banks was "not intended to take over the free market, but to preserve it."

The program is meant to be a straightforward way to beef up thinning bank reserves. Many banks have been running on fumes, working with less money because of their bad bets on mortgage-related investments. The concern about reserves is one of the reasons banks have been loath to lend to one another. They have been worried that once they lend out money, they won't get it back — a mind-set that has frozen the world's credit markets.

While the Treasury says the program is voluntary, there was some arm-twisting. Paulson met with banking executives at the Treasury on Monday and leaned on them to accept government investments even if they didn't think they needed the hand. The idea was to include healthy institutions in the recapitalization program so that banks that chose to accept the government's help wouldn't be stigmatized or seen as failing.

Paulson announced Tuesday morning that nine banks have already agreed to accept government investments "to help protect the economy." He didn't identify the institutions by name, but the group is expected to include Citigroup, Goldman Sachs, Wells Fargo, JPMorgan Chase, Bank of America, Merrill Lynch and Morgan Stanley. Executives from these banks were seen going into the Treasury to speak with Paulson on Monday.

The government will invest $125 billion in those nine banks and then make another $125 billion available to the nation's smaller, regional banks if they ask for it.

The last time the Treasury waded into the banking system in this way was in the 1930s. That's when the government set up the Reconstruction Finance Corp. to make loans and buy stakes in distressed banks during the Great Depression. The price tag at the time: $1.3 billion. The government eventually got out of the banking business when the economy stabilized. The government sold the stock it held to private investors and the banks themselves. That's expected to happen in this case, as well.

Loan Guarantees And Deposit Insurance

Under the new program, in addition to injecting some badly needed liquidity into the system, the government will also guarantee new bank debt for the next three years. That is meant to squeeze some of the uncertainty out of current lending and get credit markets moving again. For the man on the street and small-business owners, the Federal Deposit Insurance Corp. announced that it will provide unlimited insurance on non-interest-bearing accounts.

Tuesday morning, Paulson warned the bankers against stashing away the new cash infusions. They needed to actually use the money they were getting from the government, he said.

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

He looked looked pained as he announced the government's decision to move into the private sector. "We regret having to take these actions," he said. "Today's actions are not what we ever wanted to do, but today's actions are what we must do to restore confidence in our financial system."

While investors seem cheered by the announcement, the U.S. is playing catch-up. Over the weekend, European financial officials had already made many of the same moves. Britain, France, Germany and Spain flooded the international banking system with liquidity in a bid to get credit markets moving again. They said they would guarantee bank debt, take ownership stakes in banks, and shore up ailing companies with billions in taxpayer funds.

The reaction in the markets overseas was immediate. European shares have been rising. By early afternoon in Europe, the pan-European FTSEurofirst 300 index was up 6.1 percent to 994.7 points. Banking stocks overseas surged. Barclays rocketed up 18.4 percent. UBS rose 13 percent.

The U.S. Plan

The government will buy nonvoting preferred shares in qualifying financial institutions. That means that the shares will pay annual interest. The preferred shares will pay a 5 percent annual dividend for the first five years and then will rise to 9 percent after that. The interest is structured that way to encourage companies to repay the government after three years.

The downside for shareholders is that it immediately dilutes the value of existing shares and limits some of the companies' future profits because some of the banks' revenues will have to go to the government. The stakes in each institution will be limited to $25 billion or 3 percent of risk-weighted assets. The Treasury set a Nov. 14 deadline for banks to apply for the government purchases.

The new program has some strings attached. Firms that have the government buy stakes will have to accept limits on executive compensation, including forfeiting tax deductibility for compensation above $500,000 for top executives.

In return for its help, the government will also receive warrants worth 15 percent of the face value of the preferred stock. If the government makes a $10 billion investment, then it will receive $1.5 billion in warrants. The idea is that if the stock goes up and the banks get back in the black, the taxpayers will be able to share in those profits. If the stock declines, the warrants will be worthless.

In a bid to thaw interbank lending, the FDIC will guarantee 100 percent of banks' senior unsecured debt. It will also guarantee all deposits held in non-interest-bearing transaction accounts until the end of 2009. That is meant to boost confidence in the banks to prevent a run on deposits.

"The overwhelming majority of banks are strong, safe and sound," FDIC Chairman Sheila Bair said. "A lack of confidence is driving the current turmoil, and it is this lack of confidence that those guarantees are designed to address."

Taxpayers won't be footing that bill. Bair said that the guarantees will be paid for by a 75-basis-point fee paid by banks to protect their new debt issues. The FDIC also added a surcharge on top of the banks' regular deposit insurance fees.

Bailout Focus Shifts

The $700 billion bailout program was originally sold to Congress as a way to buy toxic debt from beleaguered banks. The buyback program seems to have taken a back seat to the cash infusion announced Tuesday.

The Treasury has been making progress on setting up the agency that will take on some of the bad mortgages banks have on their balance sheets. It said that it has filled several senior posts. Simpson Thacher, a Wall Street law firm, will provide legal advice to the Treasury. Ennis Knupp, a Chicago-based investment management consultant, will help the Treasury select the asset management firms that will buy the bad mortgages. It is unclear which companies will conduct the auctions for the debt. That is expected to be announced soon.

While the headline number on the stock market seems to be saying the plan will turn the tide of pessimism that has driven investors in recent weeks, there are other barometers to watch. The London Interbank Offered Rate, or LIBOR, which is what banks charge each other to borrow money, has hardly moved. The so-called TED spread, which is the difference between what banks are charging each other to borrow money over the cost of Treasuries, also hasn't budged. Those are very good indications of whether the plan is inspiring the confidence it is intended to.

Bush Remarks On Banking Rescue Plan

President Bush announced a series of steps Tuesday aimed at getting banks to resume lending, including the purchase by the government of stocks in U.S. banks. Following is a White House transcript of his remarks.

Good morning. I just completed a meeting with my working group on financial markets. We discussed the unprecedented and aggressive steps the federal government is taking to address the financial crisis. Over the past few weeks, my administration has worked with both parties in Congress to pass a financial rescue plan. Federal agencies have moved decisively to shore up struggling institutions and stabilize our markets. And the United States has worked with partners around the world to coordinate our actions to get our economies back on track.

This weekend, I met with finance ministers from the G-7 and the G-20 — organizations representing some of the world's largest and fastest-growing economies. We agreed on a coordinated plan for action to provide new liquidity, strengthen financial institutions, protect our citizens' savings, and ensure fairness and integrity in the markets. Yesterday, leaders in Europe moved forward with this plan. They announced significant steps to inject capital into their financial systems by purchasing equity in major banks. And they announced a new effort to jump-start lending by providing temporary government guarantees for bank loans. These are wise and timely actions, and they have the full support of the United States.

Today, I am announcing new measures America is taking to implement the G-7 action plan and strengthen banks across our country.

First, the federal government will use a portion of the $700 billion financial rescue plan to inject capital into banks by purchasing equity shares. This new capital will help healthy banks continue making loans to businesses and consumers. And this new capital will help struggling banks fill the hole created by losses during the financial crisis, so they can resume lending and help spur job creation and economic growth. This is an essential short-term measure to ensure the viability of America's banking system. And the program is carefully designed to encourage banks to buy these shares back from the government when the markets stabilize and they can raise capital from private investors.

Second, and effective immediately, the FDIC will temporarily guarantee most new debt issued by insured banks. This will address one of the central problems plaguing our financial system — banks have been unable to borrow money, and that has restricted their ability to lend to consumers and businesses. When money flows more freely between banks, it will make it easier for Americans to borrow for cars, and homes, and for small businesses to expand.

Third, the FDIC will immediately and temporarily expand government insurance to cover all non-interest-bearing-transaction accounts. These accounts are used primarily by small businesses to cover day-to-day operations. By insuring every dollar in these accounts, we will give small-business owners peace of mind and bring stability to the — and bring greater stability to the banking system.

Fourth, the Federal Reserve will soon finalize work on a new program to serve as a buyer of last resort for commercial paper. This is a key source of short-term financing for American businesses and financial institutions. And by unfreezing the market for commercial paper, the Federal Reserve will help American businesses meet payroll, and purchase inventory, and invest to create jobs.

In a few moments, Secretary Paulson and other members of my Working Group on Financial Markets will explain these steps in greater detail. They will make clear that each of these new programs contains safeguards to protect the taxpayers. They will make clear that the government's role will be limited and temporary. And they will make clear that these measures are not intended to take over the free market, but to preserve it.

The measures I have announced today are the latest steps in this systematic approach to address the crisis. I know Americans are deeply concerned about the stress in our financial markets, and the impact it is having on their retirement accounts, and 401(k)'s, and college savings, and other investments. I recognize that the action leaders are taking here in Washington and in European capitals can seem distant from those concerns. But these efforts are designed to directly benefit the American people by stabilizing our overall financial system and helping our economy recover.

It will take time for our efforts to have their full impact, but the American people can have confidence about our long-term economic future. We have a strategy that is broad, that is flexible and that is aimed at the root cause of our problem. Nations around the world are working together to overcome this challenge. And with confidence and determination, we will return our economies to the path of growth and prosperity.

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