U.S. To Expand Nationalization Of Banking System

Following on the heels of the Congressional approval of a $700 billion bailout bill to buy underperforming mortgage loans, the government's equity injection into the U.S. largest insurance company, the increase of FDIC bank deposit insurance, Treasury-lead aquisition of several large investment banks and the government take-over of Fannie Mae and Freddie Mac, the White House has now announced that it will take a direct equity stake in U.S. banks. This follows similar action already taken by Great Britain and also being considered by Germany.

However, even with this additional major move by the U.S. Treasury Department, world-wide credit markets remained essentially frozen and the U.S. stock market continues to plunge, now down over 40% from its highs less than a year ago. Some pundits are beginning to opine that the only way the current financial crisis can be stemmed is for banks to be totally supported with the "full faith and credit" of the U.S. government--essentially a socialized banking system.

Here's the article...

U.S. Considers Cash Injections Into Banks

By EDMUND L. ANDREWS and MARK LANDLER, The New York Times

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, the White House said on Thursday.

Acknowledging that such steps would not seem to fit into President Bush’s free-market philosophy, the president’s chief spokeswoman, Dana Perino, said taking partial ownership of banks and other moves associated with the financial rescue plan would not be “part of his natural instincts.”

“But when presented with the evidence that the financial crisis about to hit the United States would affect every single American up and down the economic food chain, this president decided that it was important that the government take robust action. That’s why we worked with Congress to establish the rescue package.”

Ms. Perino said the “capital injections” into the banks would involve “an equity stake” for the federal government but would not amount to a takeover.

“Secretary Paulson is looking at all the different tools to figure out which ones should be used at what time and how robustly and how much money to put into each,” Ms. Perino said, referring to Treasury Secretary Henry M. Paulson Jr.

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.

Ms. Perino said questions about the timetable should really be asked of the Treasury Department. At that agency, an official close to Mr. Paulson said the injections of capital into the banks could begin by the end of the month, Reuters reported.

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.

The gloomy market response 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.”

At a news conference on Wednesday, Mr. Paulson 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.

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.

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.

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 over the $85 billion loaned to the company last week.

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.”