Distasteful Capital – US government buying shares in banks

The U.S. Treasury recently announced that it will inject $125 billion into the country's nine largest banks; thus, temporarily easing fears of insolvency. Even though this gives the government ownership stakes in banks, directly re-capitalising banks is likely to prove a better tool than buying up "troubled assets," says the Wall Street Journal.

Moreover, re-capitalising banks is something the government has done before and knows how to do, and giving banks this additional capital cushion should give them some leeway to sell those assets at market prices without risking insolvency. At the same time, it avoids the vexing problem of how to price securities, says the Journal:

Under the programme, banks that participate will pay 5 percent interest annually on non-voting, senior preferred shares issued to Treasury.

Treasury will also receive warrants – equal to 15 percent of the face value of the preferred shares issued by the bank – to buy bank stock at the market price at the time of the capital injection.

For the programme to do the most good, someone needs to make sure that this capital is used to shore up the larger system, not just any banks that want it, while also protecting taxpayers.

On top of capital injections, the Federal Deposit Insurance Corporation (FDIC) will guarantee senior, unsecured bank debt issued between now and June 2009, helping banks roll over their "trust preferred" debt that would otherwise have no takers as it comes due.

The feds will also offer unlimited insurance on non-interest-bearing commercial deposit accounts, such as those used for payroll runs by businesses.

However, for free market advocates, these interventions are distasteful. Instead, the goal should be to rebuild the financial system so Americans can once again trust their banks enough that government can recede to its normal supervisory role, says the Journal.

Source: Editorial, ’Distasteful' Capital, Wall Street Journal, October 15, 2008.

For text: http://online.wsj.com/article/SB122402721776634391.html

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

FMF Policy Bulletin/ 28 October 2008