Ideology takes a back seat in bank strategy

As president, Andrew Jackson, who yielded to no one in his suspicion of bankers, essentially abolished the bank's successor in 1832. The U.S. went without any central bank until 1913, when Congress established the Federal Reserve System. The new institution, however, was a regulatory weakling, rendering it all but powerless to address the Great Depression. It was a complete overhaul during the New Deal that gave the Fed the almost unlimited monetary and regulatory authority it has been aggressively deploying in the current crisis.

By then the perils of a loss of confidence in the banking system had become all too clear. The most vivid example was the failure of another Bank of the U.S., this one a small Depression-era institution with a grandiose name that served mostly Jewish merchants in Lower Manhattan. When J.P. Morgan rebuffed regulators' pleas for a rescue, it collapsed, shattering trust in the nation's banks. The loss of faith helped trigger the Depression.

Similarly, a determination to instill confidence in banks so that they will keep credit flowing underlies the Treasury's extraordinary new steps.

"Nobody . . . believes in the rule of the 'free market' in a financial crisis," UC Berkeley economics professor J. Bradford DeLong wrote on his blog Friday.

DeLong points to the example of Sweden, which nationalized its banks during its financial crisis in 1992. After the government disposed of their troubled assets, it refloated them as public companies.

The Treasury's plan does not look quite as drastic as Sweden's. Instead, it is designed to conform more to the traditional American aversion to outright ownership. To many economists and business experts, the key is the nonvoting nature of the equity that Paulson proposes to acquire.

"It's not nationalizing the banks," said Peter Morici, a business professor at the University of Maryland and former chief economist for the U.S. International Trade Commission. "It would only be nationalizing the banks if we bought warrants, converted them into common stock and started voting the shares."

James Barth, senior fellow at the Milken Institute and former chief economist at the Office of Thrift Supervision, contended that the government should take further steps to remain a silent partner in any investment.

"There's no need for the government to change a company's directors or vote on anything," he said, "because you have a great backstop: prompt corrective action with federal regulators taking control should things get too bad."

Clearly, economic ideologies have taken a back seat to calls for quick action.

"Many countries have nationalized their banking systems over the years, then reprivatized them and become very strong," said Lawrence E. Harris, a finance professor at USC and former chief economist at the Securities and Exchange Commission. "The government will undoubtedly want to get out of the business as quickly as it can. This is certainly not the end of capitalism. Extraordinary problems require extraordinary solutions."

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michael.hiltzik@latimes.com

ken.bensinger@latimes.com

Times staff writers Peter Y. Hong, Martin Zimmerman and Henry Chu contributed to this report.