Jon Ward - Tuesday, October 14, 2008

President Bush on Tuesday morning announced a sweeping new plan to stave off the economic crisis, which will use $250 billion in taxpayer funds to purchase equity shares in major U.S. banks, in addition to an expansion of insurance for bank deposits, and other steps designed to free up the flow of capital between and among financial institutions.

"These measures are not intended to take over the free market, but to preserve it," Mr. Bush said, during a statement in the Rose Garden.

The $250 billion will come out of the $700 billion that Congress gave to the Treasury Department earlier this month, which originally was going to be used to buy up troubled assets from financial institutions.

"We must restore confidence in our financial system," said Treasury Secretary Henry Paulson, who said he regretted that he had been forced by circumstances to spearhead such a massive government intervention.

"Government owning a stake in any private U.S. company is objectionable to most Americans, me included," Mr. Paulson said. "But the alternative to leaving businesses and consumers without access to financing is totally unacceptable."

"We are acting with unprecedented speed, taking unprecedented measures that we never thought would be necessary, but they are necessary," he said.

Mr. Paulson also said it is vital that the major banks receiving government money should "not take this new capital to hoard it, but to deploy it."

By taking the more direct route of recapitalizing U.S. banks, the Bush administration is following the lead of British Prime Minister Gordon Brown, who announced similar steps for British banks late last week.

European governments on Monday also followed Britain's example, agreeing to directly capitalize struggling banks on Monday. Mr. Bush spoke to Mr. Brown, German Chancellor Angela Merkel and French President Nicolas Sarkozy on Tuesday morning.

And the White House announced that Mr. Bush will host Mr. Sarkozy, whose country currently holds the rotating chair of the European Union, and European Commission President Jose Manuel Barroso at Camp David on Saturday evening for dinner.

U.S. markets initially responded with enthusiasm to the government's announcement, with the Dow Jones Industrial Index opening up by more than 350 points. But by mid-morning the Dow had lost its gains and moved briefly into negative territory. Throughout the day it muddled around its closing mark from Monday, but then dove below a 100-point loss in the early afternoon and closed down by 76.62 points at 9,310.99.

On Monday, the Dow had raced to its biggest one-day gain ever in anticipation of the government's announcement, closing 936.42 points higher than its opening, a gain of 11 percent.

More importantly, key rates governing interbank lending were down, and rates for buying credit default swaps had also fallen.

But Mr. Bush's new plan amounts to a partial nationalization of the largest American banks.

The president said that the actions were "an essential short term measure to ensure the viability of America's banking system."

The government will buy equity shares with the intent to sell them back to banks once the economy has stabilized and institutions can raise private capital.

"The way to think about it is more of an investment in these banks," said White House deputy press secretary Tony Fratto, during an interview on Fox News.

The $250 billion will be added directly to the fiscal 2009 budget deficit prediction of $482 billion, bringing the total expected 2009 deficit to $732 billion, according to the White House Office of Management and Budget.

Mr. Paulson, who originally opposed taking ownership of U.S. banks, on Monday afternoon met with executives from nine major institutions and urged them to take part in the government's program, according to press reports.

The nine banks are: Bank of America, Merrill Lynch, Bank of New York Mellon, Citigroup, Goldman Sachs, J.P. Morgan Chase, Morgan Stanley, State Street and Wells Fargo.

Democrats reacted cautiously to the proposal.

"I think this could potentially be promising as a way of freeing up credit," said Democratic presidential candidate Barack Obama, during a brief press availability in Oregon, Ohio. "It is very important that there are some regulatory requirements ultimately that go with these injections of cash. If were just giving them money but were not making sure that they are curbing some of the excessive risks that got us into the mess in the first place, then we are just continuing the same philosophy that has failed the American people so badly."

House Speaker Nancy Pelosi, California Democrat, said the plan represented "steps in the right direction that could help to restore confidence in our financial markets and the routine flow of credit to our financial system that is essential for small businesses and consumers."

A senior Treasury Department official said that the first $125 billion would be spent in "days or weeks" to buy senior preferred stock in the first nine banks that agreed to participate.

The banks not only give the government a sizable ownership stake, but they also have agreed to new limits on executive pay and will give the Treasury warrants to purchase the banks' common stock in the future, with the pruchase price being the price of the stock at the time the bank enters the program. Lawmakers on Capitol Hill and private economists had pressed a reluctant Mr. Paulson to embrace the stock purchase idea, which gives banks immediate funds to lend and gives taxpayers a chance to profit if the banks' share prices rise

The Federal Reserve said it will begin purchasing large amounts of corporate short-term debt -- known as commercial paper -- beginning October 27. It had previously announced the program but had not revealed a start date.

And Federal Deposit Insurance Corp. head Sheila Bair said the bank backstop agency was taking two steps to bolster confidence in the banking system.

The FDIC will guarantee new senior unsecured debt issued by the banks it insures through June 30, 2009. The agency will also now fully insure non-interest-bearing deposit transaction accounts, which officials said amounted to new protection for businesses who use such accounts for payroll and other routine financial transactions. Many businesses were exposed because their accounts exceeded the $250,000 limit on federal insurance.

"The overwhelming majority of banks are strong, safe and sound," Mrs. Bair said. "A lack of confidence is driving the current turmoil, and it is this lack of confidence that these guarantees are designed to address."

Mr. Bush called these steps "unprecedented and aggressive," and said a major objective was to encourage banks to resume lending to one another, which they have not done in the past few weeks as capital has dried up.

The president tried to reassure Americans that "the government role will be limited and temporary."

"Each of these new programs includes safeguards to protect taxpayers," he said.

White House press secretary Dana Perino indicated that the stock market's nosedive last week -- its worst one-week loss in history -- may have played a role in forcing the Bush administration to change course and follow the path of direct capitalization.

"The Treasury Secretary, over time, as over the past several weeks have developed, as the legislation got passed and the credit marks changed a little bit, and we saw that terrible drop in the stock market, it was determined that one of the tools that was in the rescue package -- capital injections -- was the best possible way to move forward at this point," she said.

"I don't know how much would be used for asset purchases. That's still a part of the mix," Mrs. Perino said.

Republican presidential nominee John McCain, campaigning in Blue Bell, PA, blamed the stock market's dive last week on the "erratic behavior" of politicians.

"So much of this decline in our markets and value destruction was due to the failure of Congress and the Administration to come out with a timely rescue package," Mr. McCain said.

FDIC Chair Sheila C. Bair was asked during an interview on CNBC if the government was done unveiling pieces of their economic rescue plan.

"We have a few more pieces of ammunition if we need to use them but wer'e going to hope that this takes hold," she said.

Global markets had responded enthusiastically to similar measures taken in Europe on Monday, with Japan's Nikkei market gaining 14.5 percent on Tuesday -- its biggest one-day gain ever -- after huge losses last week.

European markets were up by an average of five percent.

David Sands and Christina Bellantoni contributed to this report.