Feds: Why Banks Will Lend Their Bailout Cash

Government officials say it's in banks' economic interests to lend out the capital.

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Much of the success of Treasury's $250 billion capital injection plan will depend on banks' willingness to lend the cash out rather than simply hoard it as protection against the rickety U.S. economy. Treasury has already earmarked $125 billion of this money for nine leading financial institutions and is now looking to get a wide array of other financial institutions to participate in the program.

During a background briefing with the press on Monday after Treasury Secretary Hank Paulson gave this address, government officials argued that the program will succeed in boosting bank lending. (Please note: Under the terms of the "background briefing," reporters weren't permitted to name the government officials who answered their questions.)

Anyway, their logic went like this:

1. Healthy banks will participate in the program because the terms are favorable. Although participating banks will be forced to accept executive compensation restrictions, government officials said the initial annual dividend rate of 5 percent makes the capital "attractive." One official said his agency has received "pretty significant" interest from financial institutions about participating in the program. Another said he expected "a lot of applications."

2. Banks will then lend out the cash because doing so makes the most economic sense. The officials argued that because banks will be restricted from using the cash to buy back shares or increase dividends, using the capital for lending is the most profitable way to make a return.

3. There are good lending opportunities out there. The tighter underwriting standards and higher down payment practices now being employed by the mortgage industry have created "good lending opportunities" for banks, a government official said. The cash injections will help alleviate the capital constraints that have been working to prevent such activity, the official said.

Here's to hoping they're right. Access to capital is one of the factors that will determine the depth and duration of America's economic pain.