WASHINGTON — The U.S. government is dramatically escalating its response to the financial crisis by planning to invest $250 billion in the country’s banks, forcing nine of the largest to accept a Treasury stake in what amounts to a partial nationalization. The news unleashed a tremendous surge in U.S. stock prices Monday.
The Dow Jones industrial average soared to the biggest percentage gain since the 1930s, up 11.1 percent. It ended 936.42 points higher, the largest point gain ever, just days after the Dow had its steepest weekly decline in history.
The surge was aided by the news that European governments also planned to take stakes in their banks.
The Treasury Department’s decision to take equity stakes in banks represents a significant reversal, coming just weeks after Treasury Secretary Henry Paulson had opposed the idea. Paulson, flanked by top financial regulators, told the executives of nine leading banks that they needed to participate in the program for the good of the national economy, two industry sources said on condition of anonymity because they were not authorized to speak publicly.
The government’s initiative, which was to be announced this morning before the markets opened for New York trading, is part of a wider plan that goes beyond the $700 billion rescue package approved by Congress this month. The Federal Deposit Insurance Corp. is also set to announce today the launch of an insurance fund to guarantee new issues of bank debt. It will provide unlimited deposit insurance for non-interest-bearing accounts, which are widely used by small businesses for payroll and other purposes.
In pressing the bank executives to accept partial government ownership, Paulson’s message was clear: Though officially the program was voluntary, the banks had little choice in the matter. In exchange for giving the Treasury minority stakes, the nine firms would jointly receive an investment worth $125 billion. The government would make another $125 billion available for the next 30 days to thousands of other banks and thrifts across the country.
Among the initial banks participating will be all of the country’s largest institutions, including Citigroup Inc., Wells Fargo & Co., JPMorgan Chase & Co, Bank of America Corp. and Morgan Stanley, said one official, according to The Associated Press.
Federal officials set conditions, telling the banks they could not raise their dividends without government permission and could not offer their executives new retirement packages, though the old packages would remain intact.
Paulson told them the moves would shore up confidence in their own institutions, spark lending throughout the system and send a message to smaller institutions that there is no stigma in accepting federal funding. Though some were reluctant, all of the executives complied.
There is a risk that banks will take the government capital and use it to bolster their balance sheets but still not resume lending, and the Treasury is not getting any specific contractual guarantee to prevent that from happening. But bank regulators, particularly the Federal Reserve, will lean heavily on the firms receiving infusions to use the capital to increase their lending to businesses and consumers.
Taken together, the steps planned by the Treasury, the FDIC and the Federal Reserve amount to a monumental effort to jump-start the business of lending, which all but dried up in recent weeks as banks have lost faith in one another and their customers. Global markets began to melt down.
Over the weekend, global leaders agreed in meetings in Washington to launch a coordinated program of injecting cash into the world’s banks and guaranteeing their debt. The action by U.S. officials Monday represented the U.S. version of those broad principles, and it was matched by similar efforts in Europe.
As part of the effort to flood the financial system with cash, the Federal Reserve made unlimited funds available early Monday to other major central banks so they could inject money into their own banks and ease the shortage of dollars they face. Previously, the Fed’s program of lending dollars to the European Central Bank, Bank of England, Bank of Japan and others had been capped at a total of $380 billion.
Under the rescue legislation signed in law this month, the Treasury is allowed to take equity stakes in banks. During debates on Capitol Hill, Paulson repeatedly described that measure as a way to shore up ailing financial institutions by buying their troubled mortgage securities and other assets.
Now that he has decided to use the $250 billion installment to pump capital directly into the banking system, he is planning to immediately ask Congress for a second installment of $100 billion to buy or insure the assets from institutions, according to congressional staff and banking industry executives briefed on the plan.
The new insurance program that will be launched by the FDIC to insure non-interest-bearing accounts is aimed mainly at small businesses, which tend to keep the largest balances in bank accounts and therefore are particularly likely to withdraw money if they think their bank is having financial problems. Because banks are barred by law from paying interest on business accounts, the new guarantee will basically encompass all such accounts.
The extended guarantee matches similar guarantees by European countries, easing a concern that businesses would move money to overseas accounts.
Dow: Questions and answers
Amid weeks of stock market turmoil, many worried investors have been tracking the daily trajectory of the Dow Jones industrial average like never before. But few understand how the index of 30 of the biggest U.S. companies is calculated — or what the closely watched measure of stock market performance really means.
Q: What is the Dow Jones industrial average?
A: The Dow, the oldest continuing U.S. market index, is a way of measuring the combined stock values of 30 big U.S. companies.
It started out with 12 components, including such now-defunct companies as U.S. Leather Co. and Tennessee Coal, Iron and Railroad Co. The only original component still around is General Electric Co.
These days, the index has expanded to reflect the U.S. economy’s move away from big industrial companies. Staples of the modern Dow include big financial companies like Citigroup Inc., technology bellwether IBM Corp. and drug manufacturer Pfizer Inc.
Q: Is the Dow considered a good measure of how the nation’s companies are generally faring in the stock market?
A: Yes and no. Some on Wall Street downplay its importance because it isn’t as broad a measure as counterparts like the Standard & Poor’s 500 index. Still, the Dow is the granddaddy of U.S. market indexes, and it offers a relatively easy-to-understand snapshot of how the market is faring. Analysts think it is a useful tool when combined with other market indicators.
Q: What are the 30 members of the index?
A: 3M, Alcoa, American Express, AT&T, Bank of America, Boeing, Caterpillar, Chevron, Citigroup, Coca-Cola, DuPont, ExxonMobil, General Electric, General Motors, Hewlett-Packard, Home Depot, Intel, IBM, Johnson & Johnson, JPMorgan Chase, Kraft Foods, McDonald’s, Merck, Microsoft, Pfizer, Procter & Gamble, United Technologies, Verizon Communications, Wal-Mart and Walt Disney. The Associated Press
