Treasury Secretary Henry M. Paulson tried to leave no doubts last week about how he expected America's banks to use the $250 billion the government is handing out as capital.
"The needs of our economy require" that the banks "deploy" the money, he said -- as loans to businesses, individuals, and, perhaps most importantly, other banks.
These were strong words, chosen perhaps to obscure how limited the government's legal authority is to require banks to do anything specific with their money.
But the words also served notice that the government intended to extract at least an implicit guarantee that it will get the maximum bang for its bucks. That means bringing a moribund bank lending market back to life.
"You'll see some gentle prodding, coupled with different forms of moral suasion," said Chris Nichols, chief executive of Banc Investment Group, which provides lending and other services to community banks.
No one expects the Treasury to go as far as British authorities, who are mandating specific lending levels for banks that have been the subject of a government rescue plan there.
U.S. law generally avoids using compulsion to govern bank lending practices. The exceptions are anti-discrimination laws such as the Community Reinvestment Act of 1977, which encourages banks to invest in their own communities and prohibits redlining neighborhoods, but still mandates that loans be "consistent with safe and sound operation" of the lending institutions.
Treasury officials may not need the majesty of the law to bend banks to their will, industry experts say. A hint of their clout came last week, when Paulson muscled nine major banks into accepting injections of up to $25 billion from the $700-billion rescue plan approved by Congress last month, overcoming resistance from several institutions. Paulson's goal was to use the big institutions' acquiescence to eliminate the stigma that direct assistance from the government might otherwise carry.
Then there's the power of the purse.
Banks seeking the money will have to apply through the agency that regulates them (the Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, Office of Thrift Supervision or the Federal Reserve). It will be up to the Treasury Department to decide which applicants get the money, and how much.
"In practical terms, they're going to select banks that are good candidates for deploying this capital," said Walter J. Mix III, a former California banking regulator who is now at the consulting firm LEGC.
Many banks are expected to be eager supplicants.
The capital comes in the form of government purchases of nonvoting preferred shares that will carry a 5% interest rate for five years. That's much less than the cost of capital that can be raised currently from other sources, industry experts say.
Banks that accept the money will have to give the government the right to purchase stock worth 15% of the capital infusion and agree to limit compensation for their top executives, but those restrictions are probably not onerous enough to counterbalance the low interest rate.
"Even the strongest-capitalized banks would be hard-pressed not to look into the program," observed analysts last week at investment bank Keefe, Bruyette & Woods, which specializes in the banking industry. They quoted an unnamed bank executive saying, "Why look a gift horse in the mouth?"
"The question to ask is whether you will need this capital any time in the next two years," said Nichols of Banc Investment Group, a unit of Pacific Coast Banker's Bank of San Francisco. "Capital is so expensive that if there is any chance you'll need it, you should get it now."
Treasury officials have not spelled out their selection standards, other than to indicate that failing banks won't be eligible for the assistance and that "systemically significant" big banks will get special attention.
A key question is how explicit the regulators will be in telling banks how to deploy the new capital. Some experts say regulators typically don't have to spell out their thoughts.
"There are a lot of informal messages and understandings that occur between regulators and their regulated banks," said Joseph T. Lynyak, an expert in bank regulatory law at the Venable law firm in Los Angeles. "People generally understand what the other side is asking for. In this case, Treasury wants to get value for their money, and the value proposition is loosening credit."
But some believe that banks applying for capital will have to give explicit assurances that they will use the money for loans.
"I think you're going to have to give your primary regulator some sort of plan for what it's going to be used for," Nichols said.
Some also believe that the government may use the capital to entice strong banks to take over weaker institutions, perhaps by allowing an acquirer to use government capital to finance the transaction.
"I think you'll see a very active process, including shotgun marriages," Mix said.