U.S. Bank Plan Hits Snag in Rules

Henry Paulson's Treasury Department said its investments in banks would count as
Henry Paulson's Treasury Department said its investments in banks would count as "Tier 1" capital. (By Jay Mallin -- Bloomberg News)
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By Binyamin Appelbaum and David Cho
Washington Post Staff Writers
Saturday, October 18, 2008

The Treasury Department is pressing federal banking regulators to change longstanding rules that are in the way of its plan to invest $250 billion in American banks, raising questions about the independence of the regulatory agencies.

Treasury's plan, announced Tuesday, rests on the ability of banks to use the government's money to buttress their core capital, the financial foundation that supports a bank's operations. Those foundations have been eroded by recent losses, limiting lending to customers and damaging the broader economy.

But under federal banking regulations at the time of the announcement, investments with the conditions attached by Treasury cannot be counted as core capital because that category is reserved for only the most stable kinds of funding.

Now, federal regulators are rushing to clear the road for the rescue plan. The Federal Reserve issued new rules Thursday evening creating a special exception for Treasury's investment. Other agencies are considering following suit.

It is the latest in a string of ad hoc measures to address the financial crisis, highlighting the haste of Treasury's massive and historic interventions and, critics say, a breakdown of the traditional separation between policymakers and banking regulators.

"Banking regulation is very complicated, and when the government is trying to jerryrig a solution, inevitably there are going to be some things that they haven't thought of," said Adam Levitin, a law professor at Georgetown University. "We might worry whether today's solution might be opening up problems tomorrow. On the other hand, it is crucial to remember that we need to live to fight another day."

In what amounted to a partial nationalization of the banking system, Treasury announced that it would invest $125 billion in nine of the nation's largest banks and an additional $125 billion in the rest of the industry. In exchange, the banks would give the government an unusual kind of stock called senior preferred shares. Holders of these shares are excluded from shareholder votes on company business, but they receive annual interest payments and their shares have priority in the event of a bankruptcy.

"The senior preferred shares will qualify as Tier 1 [core] capital," Treasury said in a release announcing the program.

Treasury officials said yesterday that they knew that the rules on core capital needed to be changed to make that true. The officials said they had conversations with the regulators before and after the plan was announced, telling them that the rule changes were necessary for the plan to work.

"As we developed the proposal, we fully consulted with the regulators, and they were directly involved in the design of this program," said Treasury spokeswoman Brookly McLaughlin. She said that the four regulatory agencies that oversee banks had expressed support for the plan, noting that the agency heads stood behind Treasury Secretary Henry M. Paulson Jr. as he announced the program.

But a spokeswoman for the Office of Thrift Supervision, which oversees savings and loans, said yesterday that the agency was reviewing the issue.

The Federal Deposit Insurance Corp., which oversees state-chartered banks, has scheduled a board meeting for Thursday to vote on whether to allow these investments to be counted as core capital.

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