YOU ARE HERE: LAT HomeCollections

Ideology takes a back seat in bank strategy

Many say scrapping free-market principles is a mistake, but others see it as the best way to get capital flowing.

October 12, 2008|Michael A. Hiltzik and Ken Bensinger | Times Staff Writers

Are we witnessing the erosion of capitalism, or its salvation?

That question is swirling around the federal government's latest proposed intervention in the private financial markets since Treasury Secretary Henry M. Paulson announced Friday a plan to take equity stakes in banks as a quick and efficient way to pump them with new capital.

Combined with the government's takeover last month of the mortgage companies Fannie Mae and Freddie Mac and its huge ownership stake in the crippled insurance company American International Group, the bank plan represents perhaps the largest federal intervention in private enterprise since President Truman's attempt to nationalize the steel industry to avert a strike in 1952 -- a move blocked by the Supreme Court.

The idea of taking direct stakes in financial institutions was adopted last week by Britain, which will in effect partly nationalize banks with as much as $87 billion in capital infusions and an additional $350 billion available for short-term loans. Some of the country's biggest banks have signed up, including Barclays and the Royal Bank of Scotland.

The Italian government has also authorized a recapitalization package to be enacted if the need arises. Germany, with Europe's biggest economy, has resisted such plans, but there were reports Saturday that Chancellor Angela Merkel might unveil a recapitalization plan as early as today.

A consensus seemed to be emerging among leaders of the world's top economies meeting Saturday in Washington that whatever economic or political differences existed among them, all countries must act aggressively and in concert in guaranteeing deposits in their banks and pumping government capital into faltering institutions to help ease the global crisis.

A stubborn seize-up of bank lending to businesses, individuals and each other has sharply heightened the prospects of a deep and lengthy recession in the U.S. and abroad.

The fact that devoted supporters of laissez-faire economics are falling in line to bless the aggressive foray into free enterprise by the U.S. government is a sign of the seriousness of the crisis.

"I'm against the government owning anything . . . ," Stanford University finance professor Jonathan Berk said. "That said, buying an equity stake may be the cheapest way" to achieve a banking recovery.

But others believe that scrapping free-market principles in a crisis atmosphere may doom the banking industry to a future of inefficiency.

"It's a move in the wrong direction, both economically and ideologically," said Casey B. Mulligan, a conservative economist at the University of Chicago who believes that predictions of an economic meltdown are overblown. "Government enterprises don't do well, because public management doesn't pay attention to the bottom line."

Paulson said the Treasury's investments would be in nonvoting stock, an important concession to conservatives and others who might be uneasy about giving government officials more direct sway over management of private institutions.

Whether the Treasury will stay out of management decisions -- or even whether it should leave the institutions in the hands of the executives who turned them into beggars for a federal lifeline -- is one of the greatest uncertainties of the program.

"I've got big reservations about the government deciding which banks need help and how they should be administered," said Bert Ely, an Alexandria, Va.-based banking consultant. "We haven't heard about the strings tied to this program. This is not going to be free capital."

Proponents contend that the new plan is sure to be a more efficient and cheaper solution to the banks' ills than the main proposal of the economic rescue package passed by Congress less than two weeks ago. That arrangement granted Treasury's request to spend as much as $700 billion to take soured assets, especially mortgages and mortgage-backed securities, off the banks' hands.

A little-noticed provision of that plan authorized direct investments in financial institutions of the sort Paulson now plans to pursue. As the rescue unfolds, the pace of the new program may well outstrip that of the original asset-purchase approach. Paulson said the government could begin these equity purchases within weeks; the mortgage securities acquisitions might not begin for a month or more.

Details of the government's bank intervention are unclear. But the Treasury may try to link its investments with parallel capital infusions by private investors, offering to contribute a stake equal to the private capital a bank raises on its own.

Los Angeles Times Articles