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Treasury Invokes Patriotism In Pitch to Bank Executives

Instead the analogy is with recent investments by Warren E. Buffett in General Electric and Goldman Sachs. In both cases, the investment was primarily symbolic. The companies needed Buffett's testimonial to their health more than they needed the money. Buffett is a director of The Washington Post Co.

This time, it is the government that wants to convince the world that the American financial system is open for business. By investing in these nine banks, the Treasury told executives it wants to send the message that "you can do business with these big companies and feel safe about it," said one person briefed on the meeting who spoke on condition of anonymity because he was not authorized to make public statements.

The goal of the program also is intensely practical, however. Massive losses on mortgage-related investments have depleted the reserves of many American banks, and fears of further losses have led many banks to hoard money and restrict lending.

The government, along with a nearly unanimous chorus of economists, thinks the best way to restart lending is to give the banks more money. In England, the government accomplished this last week by requiring banks to accept its money. But the Bush administration thought it was politically impossible to impose such a solution on thousands of smaller banks. So it sought to create a program that would persuade banks to participate by overcoming the fear that accepting government funding would send a signal to investors that the bank's financial condition was desperate.

Still, is not clear how many banks will participate. Larger banks that are publicly traded need the confidence of their shareholders and may be forced to seek government investments as an endorsement of their financial health. But there are roughly 8,500 banks in the United States, almost all of them small institutions owned by a handful of businesspeople. The American Bankers Association estimates that 95 percent of the nation's banks are well-capitalized, and many of them are not likely to see any reason to give the government a share of their profits.

To further encourage participation, the Treasury created a program with minimum strings attached.

Participating banks cannot increase their dividends unless the Treasury gives its permission. But the nine banks getting the initial infusion already pay out about $7 billion in quarterly dividends, raising questions about whether money invested by the government will simply flow through to shareholders, as through a hole in the bottom of a fire bucket, rather than staying to fund new lending.

In fact, the plan does not require banks to increase their lending, although that is its stated purpose. Banking regulators say they will watch with increased vigilance to make sure that banks do not simply hoard the money, as banks like to do during economic downturns.

It appears that participating banks will be subject to some limits on executive pay, but here, too, it is not yet clear that an actual bank executive will see a pay reduction.

The government also is expanding its efforts to reassure depositors and to encourage new investment.

The FDIC will extend its guarantee of bank deposits to include all money, without limit, in any account that doesn't pay interest. Since banks are not allowed to pay interest on business accounts, the government is effectively guaranteeing the deposits of the nation's small businesses, which keep the largest balances in bank accounts, and therefore are the most prone to destabilize a bank by pulling their money at the first sign of trouble.

The guarantee matches similar moves by European countries, easing a concern that businesses would move money to overseas accounts.

It also offers an elegant solution to some other potential pitfalls. It avoids the moral hazard of allowing banks to chase unlimited deposits by offering high interest rates, because there is no additional guarantee on accounts that pay interest. For the same reason, it could help preserve the politically important status quo in the relationship between banks and money-market mutual funds.

The new guarantee runs until the end of 2009, and it will be backstopped by the FDIC's existing insurance fund, increasing concerns about the sufficiency of that fund to cover the government's growing responsibilities as banks continue to fail.

The FDIC also is creating a new insurance fund, to guarantee investors that they will be repaid if they purchase debt issued by banks. The insurance program will be funded by premiums paid by the banks. It will cover debt issued until the end of June 2009, with terms lasting no more than another three years.

At the core of the current crisis is a breakdown in confidence that has made banks unwilling to lend money to each other, the lifeblood of a capitalist economy. But unlike European governments, the United States is not directly guaranteeing that lending between banks. The government officials who engineered the plan think that by guaranteeing banks' debts, banks will be more willing to lend to each other, confident they will get paid back.

Staff writers Neil Irwin and Zachary A. Goldfarb contributed to this report.

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