Dow Jones Reprints: This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit www.djreprints.com See a sample reprint in PDF Order a reprint of this article now format. OCTOBER 13, 2008 Treasury Hones Next Rescue Tool Direct Investments in Banks Likely Would Be Designed to Spare Existing Shareholders By DEBORAH SOLOMON and DAMIAN PALETTA WASHINGTON -- The Treasury Department's plan to inject capital directly into banks is expected to be laid out as soon as this week and will likely be designed in a way that won't wipe out existing shareholders, according to people familiar with the matter. Such a plan would overcome a problem created by the ad hoc nature of the government's interventions: Investors have refrained from putting capital into financial stocks in part over fears they would be hurt by future government involvement, as was the case when the http://online.wsj.com/article/sb122385776449927339.html (1 of 8)10/13/2008 5:15:43 AM
government took over mortgage giants Fannie Mae and Freddie Mac and took a majority stake in insurer American International Group Inc. The latest iteration of the Bush administration's rescue plan is fodder for a growing number of critics who say the government has sowed confusion during the fastmoving crisis by changing its mind about the best course of action. Outside economists and investors complain that neither the Treasury nor the Federal Reserve properly explained their rationale and the intended impact of their actions. One option currently under consideration is to inject capital in banks in exchange for preferred shares, according to Wall Street executives. That would give the government a steady payment in the form of a dividend of sorts. Another would be for banks to raise some private capital in order to qualify for a government infusion. Treasury's program would be voluntary and aimed at healthy banks, not failing institutions. While details are still being worked out, most banks likely would be able to participate in the program, though seriously troubled banks already close to failing might not be allowed to partake. The government would be a passive investor, using funds granted as part of the $700 billion bailout http://online.wsj.com/article/sb122385776449927339.html (2 of 8)10/13/2008 5:15:43 AM
package. The program could be up and running shortly, according to people familiar with the matter. Treasury Secretary Henry Paulson is also considering whether to implement a large-scale guarantee of bank lending similar to moves taken by the U.K., among others. The government is still proceeding with plans to buy assets from troubled banks and is expected to select asset managers this week. Senior Federal Reserve officials, including New York Fed president Timothy Geithner and Fed chairman Ben Bernanke, gathered at the Treasury Sunday to discuss comprehensive approaches to addressing the financial crisis, a move designed to forestall the need for another ad hoc rescue. Government officials say the U.S. was forced to take an ad hoc approach because it lacked the tools before Congress approved the $700 billion rescue plan. They say the government will now better communicate its strategy, a process that began last week when the President's Working Group on Financial Markets outlined the steps taken so far. "We said in March we didn't have sufficient tools for the modern financial system. [House Financial Services Committee Chairman Barney] Frank said it would be http://online.wsj.com/article/sb122385776449927339.html (3 of 8)10/13/2008 5:15:43 AM
next year before we got legislation and so we should make due with the tools we had and that means having to be ad hoc," said Michele Davis, a Treasury spokeswoman. Now that the administration has the tools it needs, it plans to explain to investors how it is using them, she said. Few criticize Mr. Paulson and Federal Reserve Chairman Ben Bernanke for shifting plans as market conditions eclipsed previous efforts. But C. Fred Bergsten, a Treasury official during the Carter administration, and others argue that policy makers erred in not clearly articulating what they are doing and how they are doing it. "Even sophisticated investors need to understand basic strategy," said Mr. Bergsten, who is now director of the Peterson Institute for International Economics, a Washington-based think tank. "They have not taken the time or been effective in articulating the breadth and depth of what they have done." Treasury has provided few details of how its $700 billion plan to buy troubled assets will work and has struggled to explain the efficacy of such a move. Mr. Paulson sent mixed signals about capital injections, hinting at the idea in public last Wednesday before refusing to say whether the U.S. was considering such a step. Two days later he http://online.wsj.com/article/sb122385776449927339.html (4 of 8)10/13/2008 5:15:43 AM
said Treasury would invest directly in banks. Mr. Paulson initially resisted many of the steps he has been forced to take. He didn't want to inject capital directly into banks because he didn't think it would be effective and worried about picking winners and losers. He was also concerned banks wouldn't participate because of the perceived stigma and the potential for the government to meddle in their affairs, according to people familiar with the matter. "We took a proposal from the secretary, and frankly, it was the Congress that explicitly added the right to buy the equity," said Mr. Frank, a Massachusetts Democrats, on ABC's "This Week". "Frankly, the Treasury was not too crazy about that." More broadly, Mr. Paulson didn't see a need for any type of government rescue plan until last month. As recently as May, Mr. Paulson was predicting that the "worst is likely to be behind us." Privately, Treasury and the Fed were drawing up contingency plans. But Mr. Paulson had little intention of pulling the trigger, worried that such a dramatic move might itself cause a panic. Instead, Treasury focused on private-sector solutions to the housing mess, such as a voluntary mortgage-industry effort to help troubled http://online.wsj.com/article/sb122385776449927339.html (5 of 8)10/13/2008 5:15:43 AM
homeowners renegotiate loans. After the near-collapse of Bear Stearns in March, New York Fed President Mr. Geithner privately warned Mr. Paulson and Robert K. Steel, then a top Treasury official, that financial markets were unsettled about the government's relationship with mortgage-housing giants Fannie Mae and Freddie Mac. Mr. Geithner argued for strengthening the government guarantee to back the pair's liabilities, people familiar with the matter said. Messrs. Paulson and Steel resisted and instead pushed the companies to raise more capital instead of putting taxpayers on the hook. In late summer, the U.S. government seized both companies to prevent a collapse that would have caused severe problems to financial markets. In April, Harvard economist Martin Feldstein traveled to Washington to brief Mr. Paulson on the idea of the federal government offering low-interest loans to replace 20% of the mortgage for any homeowner. Mr. Paulson rejected the plan, in part because he saw it as unworkable but also because he feared going to Congress with such a proposal would suggest the U.S. was in a deep financial crisis, according to people familiar with the matter. http://online.wsj.com/article/sb122385776449927339.html (6 of 8)10/13/2008 5:15:43 AM
Now, the question is not whether Treasury went too far. "I honestly do worry that the $700 billion may not be enough," said Robert Litan, a senior fellow at the Brookings Institution and former Clinton administration official. He doesn't fault the government for its approach, saying it would have been hard for Mr. Paulson to go to Congress earlier and ask for broad authority to stem the crisis, for fear of sparking one. "They had to wait until literally the fire was at their feet and the house was burning down," he said. Jon E. Hilsenrath contributed to this article. Write to Deborah Solomon at deborah.solomon@wsj. com and Damian Paletta at damian.paletta@wsj.com Copyright 2008 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com http://online.wsj.com/article/sb122385776449927339.html (7 of 8)10/13/2008 5:15:43 AM