Outside editorial: Banking bailout: Time to hang on

Posted: Sunday, October 19, 2008

The federal government's infusion of $250 billion for major banks, with very few strings attached, should help restore confidence in the financial industry.

But it's become increasingly clear that the broader economy faces more pain, more job losses, and a longer recovery. That means policymakers in Washington must focus more attention on struggling families and job creation.

The nine large banks receiving Treasury's initial outlay will now be better able to lend and borrow. But the fact that the government has given them nearly a blank check compels these institutions to follow through on the expectation, as Treasury Secretary Henry Paulson Jr. put it, to "deploy" capital.

Community banks don't like the plan announced Tuesday by President Bush, saying their larger competitors are being rewarded for irresponsible lending. Small banks, meanwhile, don't need as much help because many of them didn't buy into risky subprime mortgages.

As drastic as this step was, Treasury probably didn't have much choice. The panic in the credit market was preventing even the most profitable of companies from obtaining short-term loans to finance their operations, such as making payroll.

European governments led the way by making similar investments in their banks to ease the global credit crisis. Their concerted action apparently convinced the Bush administration to make a move that Paulson had earlier resisted.

Treasury will buy $250 billion of preferred stock in banks, using part of the $700 billion bailout approved by Congress and the president two weeks ago. The government's preferred stock will pay a 5 percent dividend for the first five years.

As part of the deal, banks will be restricted in what they can pay their executives as long as the government is an investor. The idea is to discourage CEOs from making risky investments. That feature was needed to allay public anger as well.

This plan is intended to spur lending, not to reward bank shareholders with lucrative dividends. But more assurances that taxpayer dollars will not end up in the pockets of shareholders are needed. Paulson hasn't addressed that concern.

He also insists this rescue is temporary. But weaning the financial industry off this free milk could be difficult in the years ahead.

Nor has this plan soothed the stock market. The Dow fell more than 800 points in the last two days, largely erasing the gains from Monday's huge rally. It's a sign that investors are still worried about the health of the wider economy.

There's good reason for that investor skepticism. Nearly nine out of 10 people think the country is on the wrong track, and consumer confidence has plummeted. Consumer spending accounts for about two-thirds of the economy.

Congress is talking about passing another stimulus package, this one aimed at Main Street. Speaker Nancy Pelosi, D-Calif., is advocating as much as $300 billion for infrastructure, job creation, food stamps, unemployment insurance, and health care for children and seniors.

These are costly steps, but they may well be needed to help people through an economic downturn that looks to be prolonged and severe.

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