Will the US Fashion a Smarter Bailout Plan?

Thursday, October 09, 2008 | 12:15 PM

So far, we in the US have had an ad hoc, half-assed, on-the-fly approach to resolving the credit and financial crisis.

The smartest bailout approach to date has been the British/Swedish/Buffett approach: Inject capital at a corporate capital structure level by buying preferred stock, rather than at the balance sheet level by buying bad assets.

Now, we read that the Treasury is considering following these other, smarter approaches:

"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."

Sure its a year late, and a trillion dollars short. Yes, this would have saved most of the firms that went belly up.

Better late than never . . .


UPDATE: October 9, 2008 2:18 pm

The way we have the government buys into a cop-any via prefereds is to match any private sector investment into banks on the same terms. So GE and Goldman Sachs get double the capital injection, and since Warren did it on those same terms, we know Uncle Sam isn't getting ripped off.   

If you cannot raise dollar one, Uncle Sam doesn't waste any good money on you.


UPDATE 2: October 9, 2008 2:40 pm>

Greg Mankiw discusses a similar approach:  How to Recapitalize the Financial System 


5 Historical Economic Crises and the U.S. (February 09, 2008)

Global Financial Crises, Part II: Norway 1987 (February 10, 2008)   

U.S. May Take Ownership Stake in Banks
NYT, October 8, 2008




A few additional takes on this:


"The U.S. Treasury Department plans to start directly injecting capital in U.S. banks as soon as the end of October in exchange for passive investment stakes, according to a financial policy source familiar with Treasury Secretary Henry Paulson's thinking.

Using authority granted to it by last week's $700 billion market rescue legislation, Treasury would get common or preferred shares in the banks it capitalizes, the source told Reuters on Thursday. The government does not intend to seek seats on companies' board of directors in the voluntary capitalization program.

White House spokeswoman Dana Perino said later on Thursday that Paulson is "actively considering" capital injections into troubled U.S. banks.

"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," she said.

A Treasury spokesperson declined to comment in detail but said: "Treasury has broad, flexible authorities under the financial rescue legislation to buy assets, provide guarantees and inject capital and intends to consider all of them."


"Britain’s government offered banks like Royal Bank of Scotland, Barclays and HSBC Holdings up to £50 billion, or $87 billion, to shore up their capital in exchange for preference shares. It will also provide a guarantee of about £250 billion to help banks refinance debt and the Bank of England will double the amount it lends to banks under the special liquidity scheme to £200 billion.

“This is not a time for outdated thinking,” Prime Minister Gordon Brown said Wednesday. “We had to do more than just buy up assets.”

The package, mainly put together in the last 48 hours, was intended to restore trust in British banks that saw billions of pounds wiped off their market values. Its aim is to allow banks to again lend to each other and as a result to consumers and companies to try and prevent a dramatic downturn. Executives, investors and lawmakers welcomed the package as a first step to stabilize the banking system."


"Treasury Secretary Henry Paulson signaled the government may invest in banks as the next step in trying to resolve the deepening credit crisis.

Paulson told reporters in Washington yesterday that legislation Congress passed last week to rescue financial institutions gave him broad authority that he intends to use, beyond just buying mortgage-related assets on banks' balance sheets. He indicated that an option available may be boosting companies' capital with cash infusions.

"It is the policy of the federal government to use all resources at its disposal to make our financial system stronger,'' Paulson said. "We will use all of the tools we've been given to maximum effectiveness, including strengthening the capitalization of financial institutions of every size.''

Banks worldwide aren't raising enough capital to offset losses: while posting $592 billion of writedowns and losses during the crisis, they have added just $442.5 billion of new capital, according to data compiled by Bloomberg. The International Monetary Fund anticipates losses will more than double to $1.4 trillion."


"Hard-hit British banking stocks recovered after the government announced a 50 billion pound ($88 billion) plan to partly nationalize major banks and promised to guarantee a further 250 billion pounds ($438 billion) of bank loans to shore up the beleaguered sector amid the world financial crisis.

But the drastic moves failed to soothe wildly fluctuating markets, and many shares ended Wednesday sharply lower.

Prime Minister Gordon Brown billed it as a "radical" plan to stabilize banks so that they could resume normal lending and other operations, rather than trying to buy up bad assets as the United States is doing.

"All these are investments being made by the government which will earn a proper return for the taxpayer," he told a news conference. "This support is on commercial terms. We expect to be rewarded for the support we provide."

At the same time, the Bank of England made at least 200 billion pounds ($350 billion) in short-term loans available to banks to help restore liquidity to the frozen credit market.


"The Bank of England has extended the collateral it will accept for the Special Liquidity Scheme (SLS) and other open market funding operations. Use of the SLS, which allows banks to swap untradeable mortgage securities for liquid Treasury assets, is also being extended from the early estimate of £50bn to £200bn.

Widening the range of collateral that is eligible will make it easier to access the SLS as well as the Bank's weekly funding operations, for three month, one week and overnight money. Any asset that is backed by a Treasury guarantee will now be eligible for acceptance by the Bank of England when previously only AAA-rated mortgages qualified. The collateral extension will allow the banks to replace with lower quality assets the estimated £100bn of AAA-rated securities already deposited at the SLS. The banks will then be able to use their best assets in the money markets to help get them moving again.

The Bank of England will continue to demand a "haircut" on the assets, swapping gilts worth less than the assets being deposited, and charge a punitive rate for use of the scheme, which remains open until January 31. A long-term replacement will be unveiled next week."

Paulson Signals Treasury May Invest Capital in Banks
Rebecca Christie and Simon Kennedy
Bloomberg, Oct. 9 2008

How authorization to recapitalize banks via public capital injections (“partial nationalization”) was introduced - indirectly through the back door - into the TARP legislation
Nouriel Roubini
RGE, Oct 9, 2008   

Treasury may capitalize banks by end of October
Reuters  Oct 9, 2008 1:27pm EDT   

Financial Crisis: What does the bail-out plan actually mean?
Telegraph  1:10AM BST 09 Oct 2008

UK steps in to save its banks, cuts interest rates
Associated Press, October 9, 2008   

Britain Announces Huge Bank Bailout 
NYT, October 8, 2008

Thursday, October 09, 2008 | 12:15 PM | Permalink | Comments (55) | TrackBack (0)
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Better late than never. I hope it happens. The only reason it hasn't it bad )and sad) ideology, the notion of the government owing banks and essentially (even if only temporarily) 'nationalizing' the industry is just too much for the old political establishment obsessed with Laissez-Faire (pronounced dead by the President of France on Sept. 25th) and free markets.

The bigger problem is viewing this crisis as only an Atlantic Alliance event. Yesterday's "coordinated effort" included a rate cut by China although it was not widely reported or discussed. Fact is China, Japan, Russia, and the Mid East hold trillions of dollars. We need a true international summit between US, EU, and China, with the resource nations and fx holders like Japan, in the process, to fashion a new Bretton Woods type order. All of these measures seem to be band-aids.

Posted by: Sinomania! | Oct 9, 2008 12:23:18 PM

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