Questions and answers about new bank rescue efforts

McClatchy NewspapersOctober 12, 2008 

WASHINGTON - By adopting a banking rescue plan based on efforts in Great Britain, European leaders took a very different approach from Washington's.

Here's how they're different and why it matters.

Q: Just what did the Europeans and Brits do?

A: They opted for a plan that seeks to guarantee loans between banks, called inter-bank lending, for a period of up to five years. They also gave each member country in the European Union the right to take equity stakes in banks.

Q: How does that differ from the Bush administration's approach?

A: Although the U.S. may go the way of its trans-Atlantic partners, its $700 billion rescue plan sought to buy bad assets directly from troubled financial institutions - mostly distressed mortgage bonds. The hope was that this would shore up their balance sheets, so they could raise capital and resume lending.

Q: Why are Britain and the Europeans focused on banks while the United States is looking at mortgages?

A: The main problem in the United States is complicated bond-like instruments called mortgage-backed securities. They are the origin of this whole financial crisis, and as banks who held these bonds took bigger and bigger losses, it contaminated the U.S. and later the global financial system.

Q: So?

A: Europeans are focused on what's called liquidity, or access to capital, since banks are not willing to lend to each other in this environment of panic. The U.S. Federal Reserve has pumped more than $800 billion in short-term lending to its banks to address this liquidity crisis. But the laws that govern it give it greater flexibility than the European Central Bank have. European governments have to inject money into undercapitalized banks directly.

Q: Why isn't this injection happening here too?

A: Late Friday, Treasury Secretary Henry Paulson confirmed that Congress gave him flexibility and that the United States too might inject money into banks. He has provided scant detail on how this will work, who will qualify or what the terms are.

Q: Doesn't this all amount to nationalizing the banks?

A: Technically no. In Britain, the government is expected to take preferred shares of future stock as part of its injection of capital into the troubled banks. Assuming the same approach happens here, this would protect existing shareholders since giving the U.S. government preferential treatment might benefit taxpayers but discourage investment in the banks. As it is, any time the government takes a stake in a bank it goes down the slippery slope of picking winners and losers in a free market.

Q: Has the U.S. government ever taken over or invested in a bank?

A: The Federal Deposit Insurance Corp. routinely seizes poorly performing banks and distributes their assets to stronger banks in a move to ensure that depositors are protected. The last time the U.S. government took an ownership stake in banks was in 1932, amid the Great Depression. In the era of Herbert Hoover, Congress created the Reconstruction Finance Corp. Over the next quarter century this government agency provided financial aid to banks, railroads, agriculture. It fell victim, as government involvement in business often does, to corruption. President Dwight D. Eisenhower took away the RFC's lending powers in 1953.

Q: Could an RFC-type entity work today?

A: Maybe. Like water finding its way into a rotting foundation in a house, the current financial crisis is quickly spilling into all sorts of surprising areas of corporate America. The Federal Reserve has started purchasing short-term debt directly from major corporations since banks cannot or are not willing to lend right now. This lack of lending is commonly called the credit crisis, and the tight financial conditions have prompted General Motors and Chrysler over the weekend to begin discussing a merger. Congress gave Treasury Secretary Henry Paulson wide powers under the recently passed $700 billion rescue package. He is creating a Troubled Asset Relief Program, or TARP. Paulson said Friday night that his office is working around the clock but wants to get right and would not set any timetables for when he announces what sort of assets he'll buy or invest in.

Treasury has already put out a request for companies to serve as asset managers, and accountants to help put this program in place. Bid winners could be announced as early this week. Paulson also appointed a former Goldman Sachs investment banker, Neel Kashkari, as the point man for the rescue effort. Kashkari is scheduled to give a much-anticipated speech on Monday morning that may give more details about the Bush administration's plans.

Treasury's special website on rescue package

Archive guide on Reconstruction Finance Corp.

To ask a question about this story or any economic question, go to McClatchy's economy Q&A

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