A drastic new plan to shore up the banks

What happened

In the largest federal intervention in the banking system since the Great Depression, the government this week unveiled a stunning $250 billion plan to partially nationalize U.S. banks. Under the plan, the U.S. will spend $125 billion on new stock issued by the nine largest U.S. banks, with an additional $125 billion going to regional and community banks. The moves were coordinated with similar capital injections by the British and E.U. governments, and are designed to create confidence in the banks’ solvency and free up paralyzed credit markets. Treasury Secretary Henry Paulson called the measures “distasteful,” but said the extraordinary government investment was the best way to get banks to resume making loans and kick-start the economy. “The needs of our economy require that our financial institutions not take this new capital to hoard it but to deploy it,” he said.

Financial markets initially welcomed the news, sending the Dow Jones industrial average soaring 11 percent, or 936 points on Monday—its largest one-day point gain ever. But stocks fell again amid growing concern that even this latest bailout could not avert a recession. Stock markets worldwide last week had fallen 20 percent or more, as investors dumped their holdings after banks around the world all but ceased lending to one another, fearing that other banks could fail without warning. Consumer lending also had dried up.

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What the editorials said

The government’s latest bailout “seems to have stopped the financial panic for now,” said The Wall Street Journal. But this is still “a dangerous moment.” Once Washington develops a taste for “politically directed credit,” it will be all too tempting for members of Congress to try to force banks to cater to their pet causes. “It would be a disaster if Congress were able to bully banks into accepting Congress’ priorities instead of rebuilding their balance sheets and exiting the program as quickly as possible.”

The problem isn’t Congress’ involvement, said The New York Times, but the administration’s lack of it. Paulson doesn’t want to oust executives of troubled banks, slash their pay, or have any say in how the banks are run. “This means the banks’ current boards and management—the same people who got the country into this mess—will still be making all of the decisions.” Congress must remind Paulson, a former Goldman Sachs investment banker, that his client is now the American taxpayer, not Wall Street.

What the columnists said

“Paradoxical as it may be,” this week’s government intervention may have saved free-market capitalism as we know it, said Larry Kudlow in National Review Online. “No free-market economy can survive without stable banking and credit,” and the administration’s actions have restored the confidence banks need to resume lending. That will set the stage for a return to the prosperity that only free markets can provide.

Now it’s Wall Street’s turn, said Steven Pearlstein in The Washington Post. The “silence and invisibility” of America’s top bankers throughout this crisis “attests to the moral and political bankruptcy’’ of the financial elite, whose irresponsibility now threatens the well-being of hundreds of millions of people on several continents. Wall Street can redeem itself by assuring credit to good business customers and refinancing the mortgages of homeowners who took out bad loans in good faith.

For now, the real leader of the world’s capitalist democracies is the unlikely figure of British Prime Minister Gordon Brown, said Paul Krugman in The New York Times. It was Brown who grasped the essentials of the crisis and conceived the basic outlines of the recapitalization plan that the U.S. and Europe have now adopted. “This combination of courage and decisiveness hasn’t been matched by any other Western government, least of all our own.”

What next?

The injection of capital into the banks may have stopped the runaway panic of last week, said Vikas Bajaj in The New York Times, but investors and financial institutions remain deeply shaken. Bankers are still wary of lending to all but the best customers, making it more difficult for businesses to expand and for consumers to finance big-ticket items such as cars. The extreme volatility in stock prices, said PNC Bank economist Stuart Hoffman, reflects the widespread belief that “everything the government has done is not going to prevent further deterioration in the economy.”