The Federal Government Takes First Steps to Bail Out Banks

The Treasury Department is spending the first $250 billion of the $700 billion rescue bill that Congress recently approved in an attempt to defuse the financial crisis that has dominated the headlines for weeks.  According to an article on GlobeSt.com the move – which partially nationalizes the banking system – is seen by some as conflicting with the free-market principles that typically have characterized the American economy. To shore up the United States banking system, the Treasury Department is partially nationalizing nine banks by using $125 billion to purchase minority stakes in major financial institutions.  Although the banks haven’t been named, they are believed to include Citigroup, Goldman Sachs, Wells Fargo, J.P. Morgan Chase, Bank of America, Merrill Lynch, Morgan Stanley, State Street and Bank of New York Mellon Corporation.  The Treasury Department is also expected to make the remaining $125 billion available to banks and thrifts across the country to purchase their preferred shares.

According to Treasury Secretary Henry Paulson, “Today’s actions are not what we ever wanted to do, but are what we must do to restore confidence to our financial system.  The needs of the economy require that our financial institutions not take this new capital to hoard it, but to deploy it.”  Just weeks before the presidential election, outgoing President George W. Bush sees the move as a short-term measure.  “The government’s role will be limited and temporary.  These measures are not intended to take over the free market, but to preserve it,” Bush said.

The question now is whether the banks will use the capital as the government intends – lend it to businesses and consumers again – or will they use it to sweeten their own balance sheets?  The government, no doubt, intends to exert significant pressure on the institutions to loosen credit so that people can start buying big-ticket items like houses and cars again.