It is bit perverse that the powers that be had to try all sorts of measures before considering the course of action that has been the most successful in handling financial crises, namely, letting asset prices fall and recapitalizing banks. In this case it would apparently involve taking equity stakes, say preferred stock and warrants, per the UK rescue program announced earlier today. However, best practice also involves nationaliization (wiping out shareholders, replacing incumbent top brass) and we do not appear to be there yet. The UK is closer to this model, having forced the leadership of RBS out today in tandem with an equity infusion. And note it is not clear that they will stop trying to intervene in the correction in asset prices.
A good bit of news: the Treasury may purse this play through the authority granted in the $700 bailout bill. That is a far better use of funds than buying toxic assets, which is a very indirect and costly way to achieve the same end. However, note the interpretation that banks have to request help. However, the article suggests that there may be some backtreading from Paulson’s extreme pro-industry posture that the process had to “encourage” banks to participate (recall he was able to secure completely toothless executive comp provisions, when Congress wanted something much tougher but caved fast). The plan version 2.0, for equity injections, appears to have a few teeth at least as far as executive pay is concerned, but it remains to be seen how serious these measures turn out to be.
Maybe the near universal condemnation of the TARP as originally envisaged finally got the Treasury’s attention.
From the New York Times (hat tip reader Megan):
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, still preliminary, 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…
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.”
One concern about the Treasury’s bailout plan is that it calls for limits on executive pay when capital is directly injected into a bank. The law directs Treasury officials to write compensation standards that would discourage executives from taking “unnecessary and excessive risks” and that would allow the government to recover any bonus pay that is based on stated earnings that turn out to be inaccurate. In addition, any bank in which the Treasury holds a stake would be barred from paying its chief executive a “golden parachute” package.
Treasury officials worry that aggressive government purchases, if not done properly, could alarm bank shareholders by appearing to be punitive or could be interpreted by the market as a sign that target banks were failing.
At a news conference on Wednesday, the Treasury secretary, Henry M. Paulson Jr., 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…
At the Federal Reserve in Washington, officials insisted they had not run out of options and made it clear they were willing to do whatever it took to shore up the economy.
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….
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.”