Paulson's Change in Rescue Tactics

But if the government were to buy $10 billion in troubled assets, it would free up only $10 billion for lending.

"The facts as I know them changed," Paulson said in the interview. "We got a bigger impact per taxpayer dollar with the equity injection so we went that route. . . . The philosophy has stayed the same, but the tools we employed changed."

That would come with trade-offs, though. Through asset purchases, the government has considerable power to control exactly which assets get bought and which don't. With injections of preferred stock, the government has no explicit authority to ensure that banks use the new capital to increase their lending to ordinary families and businesses. There is a risk they could become "zombie banks," technically solvent but unwilling to make new loans.

Government officials said they have been deeply worried about that risk and intend to use their regulatory power to lean on the banks to take advantage of their new capital by making new loans.

As Paulson and his colleagues last week gelled around the idea of taking ownership stakes in banks, they set about trying to figure out the details. Bernanke had long been a proponent of having the government match those investments made into banks by private investors, which would allow the market to fulfill its role in directing capital. But with the markets for private investments in banks essentially shut down, that idea was a non-starter.

The Treasury wanted to set terms that would make the investments desirable to participating banks. And it didn't want the government to end up with seats on the boards of directors or other situations that would allow government meddling in private business.

Their solution mirrored the investments that billionaire Warren E. Buffett's company recently made in Goldman Sachs and General Electric, using a vehicle called a perpetual preferred stock that functions as capital but doesn't give its owner any control over the companies.

On Sunday morning, a key meeting took place among Paulson and his Treasury co-workers, Bernanke and his colleagues from the Fed, Sheila C. Bair of the Federal Deposit Insurance Corp. and John C. Dugan of the Office of the Comptroller of the Currency. The officials concluded they had little choice but to proceed. They would make the announcement Tuesday morning, so they would have time to figure out a myriad of details and get nine of the banks most crucial to the U.S. financial system to agree to the plan.

At a 3:00 p.m. meeting Monday in the same conference room where the government leaders had come together a day earlier, Paulson laid out the plan to the banks' chief executives. Though technically voluntary, it was presented as fait accompli. As some of the executives raised objections, the meeting, with a dozen large egos crammed around one long table, became tense.

Bernanke, who had not said much, chimed in. "I don't really understand why there needs to be so much tension about this," he said. Bernanke told them the government investments would be good for chief executives, good for the banks, good for financial markets, good for credit markets and good for the real economy. That eased some tension.

Still, the executives had to go back to their boards of directors before acquiescing to the deal. All nine did so by 7 p.m. Monday.

The actions, including the new guarantees for bank deposits and borrowing, came too late to prevent a rout in global credit markets that market insiders predict will take time to heal. It came too late to help Wachovia. "With Wachovia, it definitely would have made a difference," said Bair of the FDIC.

Congressional leaders were pleased with Paulson's reversal.

"I think this is the right move in the right direction, and I applaud the secretary of the Treasury for taking this step," Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.) told reporters yesterday. Had the original rescue plan not included the authority to make cash injections, he said, Congress would probably be back seeking it now.

House Minority Whip Roy Blunt (R-Mo.), the lead House GOP negotiator on the bailout package, also expressed support for the new Treasury initiative, suggesting that House Republicans supported taking stakes in the banks and firms as a way to provide immediate capital while also creating "an almost certain guarantee" that the government would recoup its expenditures.

Staff writers Paul Kane and Binyamin Appelbaum contributed to this report.