Interest Rate Roundup

Thursday, October 09, 2008

The latest plan to save the world: Direct equity investments in banks

According to several media sources, the latest government plan to save the financial world is to inject money directly into the banking system by exchanging equity for shares in weak banks. This is similar to the plan recently proposed in the U.K. and it makes a good deal of sense. More details ...

From CNNMoney:

"The Treasury Department is "actively" looking at buying equity stakes in some of the nation's banks, according to White House spokesperson Dana Perino.

"At a White House briefing on Thursday, Perino confirmed reports that the United States could soon join the United Kingdom, Iceland and Italy in announcing a plan to inject capital directly into their troubled banking systems.

"These capital injections are something that Secretary Paulson is actively considering," said Perino. She said she couldn't comment on the timing or extent of such investments.

"The move would be made under the $700 billion Wall Street bailout law enacted on Friday.

"The focus of the bailout was a plan to have Treasury buying damaged mortgage-backed securities from banks and financial firms. The aim is to help firms improve their balance sheets and profit prospects and attract capital from the private sector. But the administration is now arguing that direct investment is part of the powers under the act.

"Treasury Secretary Henry Paulson first hinted of such a move Wednesday in a speech about the bailout. He said increasing capital investment in the nation's banking system is one of Treasury's goals, and he seemed to suggest that such capital could come directly from taxpayers.

"The new law gives "broad flexible authorities for Treasury to buy or insure troubled assets, provide guarantees, and inject capital," Paulson said.

"Paulson vowed to "use all of the tools we've been given ... including strengthening the capitalization of financial institutions of every size."

And from the New York Times:

"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, according to government officials.

"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.

"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."


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