Will the Government Buy Stakes in U.S. Banks?

The Feds may go deeper into the private markets by taking equity positions in banks.

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It wasn't that long ago that the government received sweeping authority to purchase $700 billion of distressed mortgage and other assets. But now the Treasury Department appears increasingly likely to take direct equity stakes in U.S. banks—a move that would further Uncle Sam's already historic intervention into private enterprise.

"I'll be very surprised if they don't [inject capital into banks]," says a former Treasury official.

Shortly after the British government unveiled a plan to put as much as $87 billion into its banks in exchange for shares in the companies, Treasury Secretary Henry Paulson highlighted the federal government's newly acquired authority to take similar measures.

The recently enacted bailout "empowers Treasury to use up to $700 billion to inject capital into financial institutions," Paulson said Wednesday.

According to a person familiar with the matter, the Treasury Department could release details on a plan to buy equity stakes in U.S. banks as soon as today. These details could come in the form of internal guidelines for how the program would work or possibly even a list of which banks would receive capital. The source said that Treasury is likely to take 5 percent to 15 percent stakes in midsize banks with exposure to the troubled mortgage market. Such stakes would be noncontrolling, the source said.

Taking equity stakes in banks "is something that is on the table," says Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable. "It would be an extraordinary measure for an extraordinary time."

The equity capital plan would likely work in concert with efforts to relieve banks of troubled assets as the government scrambles to address the worst financial crisis since the Great Depression. "The two [initiatives] really need to be done together," says Stephen Stanley, chief economist at RBS Greenwich Capital.

Such a capital injection plan would have several distinct benefits, observers say.

They include:

1. Capital cushion

As the banking system has recorded steep losses on mortgage-related investments and loan delinquencies, capital bases have eroded. At the same time, private-sector sources of capital have grown elusive. "The idea is to have the government put equity into these banks to give them a capital cushion so that if they did get hit with write-downs, they could stay in business," says Robert Wescott, president of Keybridge Research. 2. Speed

Lyle Gramley, a former Fed governor who is now a senior economic adviser at the Stanford Group, says the government can recapitalize banks much faster than it can get the bad assets off their books. "It was going to take 30 to 45, maybe even 60 days to get up to speed on reverse auctions," Gramley says. "The FDIC has detailed information on the capital position of every bank that is insured—so they can go down that list and in a matter of a few days" put the capital into banks. "That just sounds like a good idea at this point," he adds. 3. Confidence

Gramley argues that recapitalizing banks would help rebuild Americans' confidence in the financial system. "There have been a lot of people starting to pull their money out of their banks and putting it under a mattress—that has to stop," he says. At the same time, he says, the cash injections may get banks lending again. "The thing that is stopping the banks [from lending] is only partly capital—some of it is fear that the economy is going down the tubes," Gramley says. "But if you can overcome the capital problem, you've got a lot better chance of breaking the log jam." 4. Taxpayer Benefits

Although the details remain unclear, the potential capital injections could be structured to allow the taxpayer to benefit should the companies return to health. "That's really what this is all about," Wescott says. Should the value of the government's stakes increase over time, "taxpayers could also make a hefty little return," he says.