Treasury bids to free up lending with cash infusion to banks

WASHINGTON -- The Treasury Department's extraordinary announcement Tuesday that it will buy as much as $250 billion in stock to shore up the nation's banking system is designed not to undermine free-market capitalism — but to save it. But will it work?

Government officials, including President Bush and Treasury Secretary Henry Paulson, expressed hope that the historic move will free up bank lending, quell a spreading financial panic and send a message to vital foreign investors that the USA remains one of the most attractive places to put their money.

And yet the proposal is perhaps the most exceptional federal intervention in the banking sector since the Great Depression. Still, it stops well short of outright nationalization of banks and thrifts. The Treasury Department will not be involved in day-to-day bank management and will not exercise stock voting rights except in special cases. Participation will be voluntary, though the nine major banks that agreed to participate did so under pressure.

"It's an uncomfortable feeling for Americans to consider taking gigantic stakes in the banking industry … but it's a better way to get the system working again," says David C. Smith, associate professor at the University of Virginia. "We are in territory that we have not been in, in modern times — since the 1930s."

Economists and lawmakers, while acknowledging risks, generally applauded the plan, noting that every $1 in bank capitalization frees up as much as $10 in new lending. Martin Bailey, a fellow at the non-profit Brookings Institution, questioned whether the government demanded a big enough return on its investment. Mega-investor Warren Buffett, for example, got preferred stock paying a 10% dividend for a recent investment in General Electric. The Treasury will get half that much, initially.

Money manager Ken Winans of Winans International notes that the market for the kind of stock Treasury is buying from banks is very small, which could make it tougher for the government to sell shares later. Some economists fretted that the government would exercise too much control over banks, pointing to the first-ever limits on executive compensation for lenders that participate. Others said Treasury didn't demand sufficient management changes in return for aid.