Government to Invest in Banks

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10 · 14 · 08

Some of the $700 billion Troubled Asset Relief Program will be used for the U.S. government to invest directly in U.S. banks. The rescue package also includes bank loan guarantees and provisions to stabilize the commercial paper market.

In a news conference this morning, President Bush said the federal government will purchase equity shares using funds from the $700 billion financial rescue plan. Once the market stabilizes, banks will be encouraged to buy back the government’s shares with funds they raise on their own.

He called the move a short-term measure that will ensure the U.S. banking system remains viable.

“This new capital will help healthy banks continue making loans to businesses and consumers,” Bush said at a Rose Garden press conference. “And this new capital will help struggling banks fill the hole created by losses during the financial crisis so they can resume lending.”

Nine large, healthy institutions have already voluntarily agreed to participate. Terms are the same for large and small firms.

The move has the U.S. Department of the Treasury purchasing up to $250 billion of non-voting senior preferred shares of qualifying U.S. financial institutions, a statement from the Treasury said. The deadline for the firms to elect to participate is Nov. 14, while funding will occur by Dec. 31.

photo of George Bush
White House photo of George Bush

A minimum of 1 percent of risk-weighted assets is available to institutions that participate, while the maximum is $25 billion or 3 percent of risk-weighted assets, the Treasury said.

The preferred shares, which can be transferred to a third party at any time, will pay a cumulative annual dividend rate of 5 percent for the first five years, then reset to 9 percent, according to the Treasury statement. They will be callable after three years. The Treasury will also receive warrants to purchase common stock with an aggregate market price equal to 15 percent of the senior preferred investment and an exercise price based on market price at issuance.

Participating companies must adopt compensation limitations for the chief executive officer, chief financial officer and the next three most highly compensated executives, the Treasury said. Among the compensation limitations are a maximum deduction of $500,000, a prohibition on the deduction of golden parachute payments and a clawback provision.

“We regret having to take these actions,” Treasury Secretary Henry M. Paulson Jr. said in a statement. “Government owning a stake in any private U.S. company is objectionable to most Americans — me included. Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable.”

Bush said the measure also includes a guarantee by the Federal Deposit Insurance Corporation of most new debt issued by insured U.S. banks. He noted this immediate move will address the central problem that has been dogging the U.S. financial system — the inability of banks to borrow.

FDIC will also immediately insure all non-interest bearing transaction accounts, which are typically used by small business owners, Bush said. The move is designed to bring “peace of mind” to small business owners.

Another move, which is still being finalized, has the Federal Reserve serving as a buyer of last resort in the frozen commercial paper market.

“By unfreezing the market for commercial paper, the Federal Reserve will help American businesses meet payroll and purchase inventory and invest to create jobs,” he added.

Bush noted the move follows similar moves by European governments to purchase equity in some of their major banks and provide government guarantees for bank loans.

“Each of these new programs contains safeguards to protect the taxpayer,” Bush said. “The government’s role will be limited and temporary.”

He added that “these measures are not intended to take over the free market, but to preserve it.”

The American Bankers Association issued a statement throwing its support behind the action, though it was not the program it sought.

“It is noteworthy that those banks which today announced they would be participating in the program are, like the great majority of U.S. banks, already well capitalized,” ABA President and CEO Edward L. Yingling said in a statement. “While the capital program is available to all banks, given that 95 percent of our banks are well capitalized, we would not expect most banks to participate.”

The trade group reiterated yesterday’s call for the Securities and Exchange Commission to override a recent accounting pronouncement on mark-to-market accounting.

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