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UPDATED: Paulson reluctantly agrees to recapitalize

- The Washington Times - Wednesday, October 15, 2008

UPDATED:

WASHINGTON (AP) – Confidence and cash will restore the economy's health, but it will take time and patience, too, Treasury Secretary Henry Paulson said Wednesday.

A day after announcing a $250 billion cash infusion into the nation's banks in return for a stake in those institutions, Paulson said the plan should stabilize the system, induce banks to lend again, and -- eventually -- help improve the economy.

"This will take time. There will be challenges," he told a worried country.

The secretary was interviewed on ABC's "Good Morning America." He acknowledged that he initially opposed government intervention into the banking industry but that new facts changed the circumstances in recent days.

Paulson said, "There's no doubt that the way to get the maximum bang for the taxpayers here was to invest in banks."

He said he was more confident the system would right itself because of the steps the U.S. and other countries had taken recently to pry open locked lending that has stifled the global economy.

U.S. stocks appeared headed for a mixed opening, despite the plan, as investors turned their gaze toward the hurdles the economy faces: vanishing jobs, shrinking paychecks and nest eggs, and slumping home values continue to force millions of Americans to pull back.

Sales at the nation's retailers are expected to drop in September even as they get a break from record-high energy prices. Uncertainty about the economy -- and their own financial fortunes -- probably will force consumers and businesses alike to hunker down further, spelling more problems for the already troubled economy.

Anxiety about the economy is the No. 1 concern of voters. With the presidential election just weeks away, Democrat Barack Obama and Republican rival John McCain are working furiously to convince people that each is the best choice to steer the economy through these perilous times.

In addition to September retail sales numbers, other economic data out Wednesday is expected to show that even though the recent retreat in energy prices calmed inflation at the wholesale level bit, costs are still high and are squeezing businesses.

Many economists believe the country is on the edge of -- or already in -- its first recession since 2001.

If the government's new plan works -- it will merely cushion the blow. Democrats on Capitol Hill are pushing for another round of stimulus that could cost as much as $150 billion, an effort to provide additional relief and lift the country out of the doldrums.

Federal Reserve Chairman Ben Bernanke will provide an up-to-date assessment of the country's economic and financial challenges in a speech in New York on Wednesday.

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(Editor's note: The following text is the original story filed by Washington Times staff writer David R. Sands.)

It was, by all accounts, a remarkable about-face.

Treasury Secretary Henry M. Paulson Jr., economic point man for a conservative Republican administration and former chairman of Wall Street investment powerhouse Goldman Sachs, faced the press in the department's ornate, gilt-edged Cash Room Tuesday to spell out just how he planned to administer the most massive government intervention in the financial markets in the history of the republic.

"We regret having to take these actions," a somber Mr. Paulson said.

"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."

President Bush, in a statement from the Rose Garden, tried to reassure Americans that "the government role will be limited and temporary."

"Each of these new programs includes safeguards to protect taxpayers," Mr. Bush said. "These measures are not intended to take over the free market, but to preserve it."

Peer pressure - from foreign regulators, from anxious market traders and from a number of top economists - forced Mr. Paulson to reverse course. The Treasury secretary Tuesday embraced an idea he had long and steadfastly opposed: to use taxpayer money to recapitalize U.S. banks, guarantee interbank lending and thaw frozen credit markets.

In Europe and Asia, led by British Prime Minister Gordon Brown, governments over the weekend called essentially the same play, pumping billions into their struggling banks, boosting deposit insurance limits and standing behind interbank lending. The United States risked being the odd man out.

"Given that many countries were already moving to guarantee bank debt, this action was needed for competitive equity," said Edward L. Yingling, president of the American Bankers Association.

The pressure only grew when global stock markets scored record gains Monday on news of the coordinated European action and on widespread hopes that the Bush administration was about to follow suit.

A senior Treasury official, briefing reporters afterward, said that the first $125 billion of the recapitalization program would be spent in "days or weeks" to buy senior preferred stock in the first nine banks that agreed to participate. The nine included Goldman Sachs Inc., Mr. Paulson's old employer; Citigroup Inc.; Wells Fargo & Co.; JPMorgan Chase & Co.; Bank of America Corp.; Merrill Lynch & Co.; Morgan Stanley; State Street Corp.; and Bank of New York Mellon Corp.

The government could spend another $125 billion on similar share purchases by the end of the year.

The banks will give the government a sizable ownership stake and have agreed to new limits on executive pay. They also will give the Treasury warrants to purchase the banks' common stock in the future, with the purchase price being the price of the stock at the time the bank enters the program.

The Federal Reserve said it will begin purchasing large amounts of corporate short-term debt - known as commercial paper - beginning Oct. 27. It had previously announced the program but had not revealed a start date.

And Federal Deposit Insurance Corp. head Sheila Bair said the bank backstop agency was taking two steps to bolster confidence in the banking system.

The FDIC will guarantee new senior unsecured debt issued by the banks it insures through June 30, 2009. The agency will also now fully insure non-interest-bearing deposit transaction accounts, which officials said amounted to new protection for businesses that use such accounts for payroll and other routine financial transactions.

Treasury officials declined to identify other banks and financial firms that may participate in the program through the end of the year. But House Financial Services Committee Chairman Barney Frank, Massachusetts Democrat, said in an interview on MSNBC that government officials have promised to include smaller regional and community banks in future deals.

Treasury Department officials briefing on the program denied they were playing catch-up.

But Mrs. Bair said the United States acted in part to match actions in Europe and Japan.

"Their guarantees of bank debt and increases in deposit insurance would put U.S. banks on an uneven playing field unless we acted as did today," she said.

Mr. Paulson's original script - which called for the U.S. government to use the bailout money just to buy up the toxic mortgages and mortgage-backed securities at the heart of the credit crisis - also was widely panned by economists and market strategists.

"The European actions clearly affected the Treasury timetable," said Bert Ely, a banking consultant in Alexandria. "There was a growing feeling that [Mr. Paulson's approach] was not going to do the trick and was not coming on line fast enough."

Newly awarded Nobel economics laureate Paul Krugman and other leading economists said Mr. Paulson's asset-purchase program - which the Treasury is still pursuing - did not directly attack the basic problem: getting money into the banking system to jump-start lending.

"Virtually every economist who looked at the original Treasury plan said it was the wrong way to go," said Loyola University finance professor George G. Kaufman, co-chairman of the Shadow Financial Regulatory Committee.

"All of us were disappointed that it took Paulson and the administration so long to recognize the obvious," he said.

Lawmakers of both parties had pressed the reluctant Treasury secretary to consider the recapitalization idea while the $700 billion Wall Street rescue bill was working its way through Congress. Mr. Paulson eventually agreed to accept the plan as an option, although his focus remained clearly on the purchase of bad assets.

He repeatedly slammed the idea of direct capital infusion into troubled banks when he testified on Capitol Hill on the bailout bill.

"There were some that said we should just go and stick capital in the banks, put preferred stock in them," he told a Senate Banking, Housing and Urban Affairs Committee hearing. "... But we said, the right way to do this is not going around and using guarantees or injecting capital, but to use market mechanisms."

Tuesday, in the Cash Room, Mr. Paulson said, "Today I am announcing that the Treasury will purchase equity stakes in a wide array of banks and thrifts."