Paulson Plans to Invest in `Thousands' of U.S. Banks

By Rebecca Christie and Robert Schmidt

Oct. 14 (Bloomberg) -- Treasury Secretary Henry Paulson urged banks getting $250 billion of taxpayer funds to channel the money to customers quickly to halt a credit freeze that's threatening to bankrupt companies and hammer the job market.

``Leaving businesses and consumers without access to financing is totally unacceptable,'' Paulson said in Washington. He rolled out the emergency program after a crisis of confidence in the financial system last week spurred the biggest stock sell- off since 1933. Paulson told companies getting the government funds to ``deploy'' the money in loans.

The Treasury chief was forced to change tack from an initial plan to buy distressed assets from banks after the financial panic caused banks to hoard cash and send money market rates to record levels. In its biggest effort yet to halt the 14-month credit rout, officials will also offer guarantees on new bank debts and start purchasing commercial paper in two weeks.

Previously announced auctions to buy distressed securities will still proceed, said David Nason, the Treasury's assistant secretary for financial institutions. ``We're still planning to go forward,'' he said in an interview with Bloomberg Television.

This means the Treasury is likely to call on more of the $700 billion than the initial $250 billion allotment. Under the law, the administration is able to access the rest of the money through a series of congressional notifications.

Fragile Banks

The Treasury also said it is working on another element of its plan that will specifically address banks that may be on the brink of failure. Those banks will face different guidelines than healthier firms who take part in the asset-buying and capital injection programs.

The Treasury's stock buying program will begin with nine banks, which it didn't name. People briefed on the matter said $125 billion will be disbursed in days: Citigroup Inc., Wells Fargo & Co., JPMorgan Chase & Co. and a combined Bank of America Corp./Merrill Lynch & Co. each will get $25 billion, while Morgan Stanley and Goldman Sachs Group Inc. will get $10 billion each. Bank of New York Mellon Corp. said it will receive about $3 billion and State Street Corp. said it's getting $2 billion.

`Healthy' Companies

``These are healthy institutions, and they have taken this step for the good of the U.S. economy,'' Paulson said. ``These institutions, along with thousands of others to come, will have enhanced capacity to perform their vital function of lending,'' President George W. Bush's working group on financial markets said in a separate statement.

Bush today said ``this is an essential short-term measure to ensure the viability of the U.S. banking system,'' after meeting with Paulson, Federal Reserve Chairman Ben S. Bernanke and other members of the working group, which includes the Securities and Exchange Commission and Commodity Futures Trading Commission.

Stocks rose around the world on expectations the rescue will help alleviate the credit crisis. The Standard & Poor's 500 Index rose as much as 4.1 percent today, after an 11.6 percent surge yesterday. The index lost 18 percent last week. Japan's Nikkei jumped 14.2 percent as trading resumed following yesterday's public holiday.

With the equity purchases, Paulson is using more than a third of the $700 billion in government support Congress gave him the authority to use on Oct. 3.

Executive Pay Restrictions

Participating banks will need to accept limits on executive pay and so-called golden parachute payments. They also will need to give the Treasury warrants for an amount equal to 15 percent of the senior preferred investment, with a strike price determined by the bank's share price at the time of issuance.

The senior preferred shares will pay a dividend of 5 percent for the first five years and 9 percent after that, the Treasury said. The purchase price of the stock will be the market price of the banks' common shares at the time of the transaction. Companies will be able to buy back the equity at par after three years.

The government expects to purchase equity in the nine banks within days and to use the full $250 billion by year-end, a Treasury official told reporters on condition of anonymity. While banks would not be forced to cut existing dividends, there would be some restrictions on raising them, the official said.

The Treasury does not plan to exercise any voting rights IN acquiring the shares.

Europe's Lead

The U.S. initiative followed an announcement that France, Germany, Spain, the Netherlands and Austria committed $1.8 trillion to guarantee bank loans and take stakes in lenders.

Banks have struggled to regain the confidence of investors, counterparties and clients after bad loans caused $637 billion of writedowns and losses across the industry.

A Treasury official urged banks to use the funds to increase lending.

``It's in their economic interest,'' Nason said. ``When you give them a stronger capital position and you also provide a certain amount of government backstop to their funding sources, it's incumbent upon them to go out and continue to lend.''

Last week, the International Monetary Fund estimated that banks around the world would need $675 billion in fresh capital over the next several years to recover. The IMF also said Oct. 7 that financial losses would total $1.4 trillion, an almost 50 percent increase from a prediction in April.

Commercial Paper

Under the plans announced today, the FDIC said it would fully guarantee newly issued, senior unsecured debt and non- interest bearing deposits. The expanded coverage applies to all senior unsecured debt issued on or before June 30, 2009, and deposits in FDIC-insured banks until Dec. 31, 2009.

The Fed said in a separate statement that its previously announced program to buy commercial paper will start on Oct. 27. Officials haven't indicated a limit for the total size of the fund.

Financial firms participating in the U.S.'s so-called voluntary capital purchase program will need to step up their efforts to stem mortgage foreclosures, Paulson said today. That targets the original spark of the crisis, caused by lax lending terms on subprime home loans.

``The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it,'' the Treasury chief said.

About 100 or fewer of the 7,000 U.S. banks with less than $10 billion in assets may consider taking advantage of the program, said Camden Fine, president of the Independent Community Bankers of America, a Washington trade group representing about 5,000 banks.

``The headline in the local paper that everybody's going to read is, `Local Bank Seeks Government Assistance,''' Fine said in an interview. ``That doesn't look real good to the folks in the local towns.''

To contact the reporter on this story: Rebecca Christie in Washington at Rchristie4@bloomberg.net; Robert Schmidt in Washington at rschmidt5@bloomberg.net.