First Phase of Bailout Underway

Treasury Secretary Henry Paulson announced a plan Tuesday to invest $250 billion of the approved $700 billion bailout package into perhaps hundreds of U.S. banks, according to The New York Times.

The move was announced at a press conference in Washington D.C. which was also attended by Federal Reserve Chairman Ben Bernanke and Federal Deposit Insurance Corporation Chairman Sheila Bair. In concert with the Treasury Department, the FDIC will offer unlimited temporary guarantees on all non-interest bearing bank accounts. Accounts which do not bear interest are typically those used by businesses, the move is meant to shore up confidence amidst the crumble worldwide which has stifled payroll and other business operations.

As part of the deal, approximately half of the $250 billion will be equally allocated to nine of the largest banks in the United States: Citigroup Inc, Goldman Sachs Group Inc, Wells Fargo & Co., JPMorgan Chase & Co., Bank of America Corp., Merrill Lynch & Co., Morgan Stanley, State Street Corp. and the Bank of New York Mellon Corp. Secretary Paulson hand-picked the nine largest institutions, but expects hundreds or more to be involved with the allocation of the remaining $125 billion.

The chosen banks agreed to terms which were not specifically delineated in the press conference, but included limitations on executive pay and restrictions on so-called “golden parachutes” for executives who are dismissed or demoted. While these stipulations will be eye-catching to most Americans, many of whom are disgusted by current executive salary levels, the most important part of the plan is the guarantee of senior preferred shares to the Treasury. These shares will pay special dividends to the government – 5 percent interest for five years, 9 percent interest after that – and the government will receive additional warrants worth 15 percent of the market value of their share holdings. This move is hoped to guarantee that the government will at least break even on its investment, and potentially gain profit to be shared with the taxpayers.

Immediately following the joint press conference U.S. Stock markets rose sharply in early trading Tuesday – those gains have since receded – indicating that for good or ill, the government's action is at least exerting some effect on the market.

Secretary Paulson has personally urged the major bankers involved in the bailout to do their civic duty in service to the nation in order to avoid a much larger financial collapse. The money being infused into the market is not meant to be hoarded by the institutions – approximately $13 billion each for the nine largest recipients – but is instead designed to be spread throughout the economy. This type of government intervention plan is not unheard of, but the scope and magnitude of the Treasury's plan are historic.

The United States' moves were calculated over the weekend when European governments took similar actions to buttress their faltering financial systems. Inaction on the part of the U.S. government could have precipitated a migration of capital from the U.S. to less risky operations in Europe. Hopefully, this move has staunched the bleeding which saw market prices crumble worldwide in the last week, but it is far from a cure-all for the economy.

Source The New York Times:

The Treasury Department, in its boldest move yet, is expected to announce a plan on Tuesday to invest up to $250 billion in banks, according to officials. The United States is also expected to guarantee new debt issued by banks for three years — a measure meant to encourage the banks to resume lending to one another and to customers, officials said. ... Treasury Secretary Henry M. Paulson Jr. outlined the plan to nine of the nation’s leading bankers at an afternoon meeting, officials said. He essentially told the participants that they would have to accept government investment for the good of the American financial system. ... Over the weekend, central banks flooded the system with billions of dollars in liquidity, throwing out the traditional financial playbook in favor of a series of moves that officials hoped would get banks lending again.

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