The Rescue Plan: What It Will and Won't Do

 

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When the Bush administration announced its new version of the $700 billion financial rescue plan first approved by Congress earlier this month, many observers cheered and optimism helped drive U.S. stocks to record gains.

Now, as the dust settles, economists and other experts are analyzing how the plan will help the U.S. economy -- and how it won't.

"The nature of the financial crisis has morphed from a housing problem to a credit crunch to a full blown modern day bank panic," said Kenneth Rogoff, an economics professor at Harvard University and a former economist at both the International Monetary Fund and the Federal Reserve.

Government officials, he said, "haven't solved the problem that the economy is going into a significant recession, but they've stopped the hemorrhaging."

Experts say that while the plan should help shore up banks, it won't help housing prices recover, it won't stop the U.S. from shedding jobs and it may result in higher taxes down the road. One critic questions whether the new plan is even legal.

Treasury Secretary Henry Paulson, meanwhile, has acknowledged that the plan won't stop the country from facing "some challenges for a number of months."

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Experts say the new rescue plan announced by the Bush administration may encourage lending but it won't stop housing prices from falling.

"There is no doubt that -- that a lack of confidence in the financial system, banks slowing down their lending have had an impact on the real economy," Paulson said in an interview today on Good Morning America. "And businesses haven't been borrowing, jobs have been in jeopardy, people's 401(k) plans have declined."

But, he added, "as we stabilize the system and as banks begin to lend and begin to lend to consumers, begin to lend to businesses, businesses resume hiring, we will make progress here."

Here's how the plan is supposed to work: The government will allocate $250 billion of the $700 billion package to purchase equity in U.S. banks. The list of banks include Bank of America, JPMorgan Chase, Citigroup, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon and State Street, which will receive a total of $125 billion. The government is expected to invest the remainder of the $250 billion in smaller banks.

Raising Capital and Confidence

In return for its investment in the banks, the government will receive preferred shares – stocks that don't come with voting rights but do get paid out ahead of common shareholders if a company goes bankrupt – from the banks.

According to the plan, banks will pay the government a 5 percent return on the investment – a dividend – annual for five years. At the end of the fifth year, the dividend requirement jumps to 9 percent. The government will also have the option to buy common stocks from the bank.

Participating banks will be subject to executive compensation limits set by the government.

Proponents of the plan say it will make banks more confident about lending to each other because each will know that the other has sufficient capital to cover its debts. And, they say, it will stabilize the banking system enough that banks will feel comfortable lending to consumers and businesses again.

The government hopes that the moves will aid banks in their search for private investment.