Confidence should shore up banks soon

October 13, 2008 12:00:00 AM PDT
A much-needed big bounce on Wall Street came on Monday, but what about the day after? Before the markets open, President Bush will announce a major change to the $700 billion bailout plan.

The Dow posted its largest-ever one-day point gain with 936 points. That's an 11 percent jump.

As a result, the Asian markets are soaring in Tuesday trading. Tokyo's Nikkei is up 13 percent. Hong Kong's Hang Sang is up more than four percent and Seoul's Kospi, with a gain so far of more than five percent.

The President will outline in the morning the government's plan to buy bad mortgage debt has been pushed aside. The Treasury Department now plans to invest in banks by using a big chunk of the bailout money.

The banks involved read like a who's who of the financial world: Goldman Sachs, Morgan Stanley, J.P. Morgan Chase, Bank of America, Merrill Lynch, Citigroup, and Wells Fargo among others.

The heads of nine major U.S. banks met behind closed doors Monday at the Treasury Department and during that meeting, Secretary Paulson laid out his plan to get financial institutions lending again. The Treasury Department will spend $250 billion of the $700 billion bailout buying preferred stock in small and large banks, with the large banks being the first participants.

Citigroup and J.P. Morgan Chase will get $25 billion each. Bank of America and Wells Fargo will get $20 billion each. Goldman Sachs and Morgan Stanley will get $10 billion each. In addition, Wells Fargo will receive an extra $5 billion for its acquisition of Wachovia and Bank of America will get the same amount for its purchase of Merrill Lynch.

"Preferred stock is the way to go, so I'm very glad to hear that's what they're doing. What that means is preferred stock doesn't have a vote. So we don't have to worry about the government controlling businesses which generally we don't think is a good idea," says Professor Jonathan Berk, Ph.D., from Stanford's Graduate School of Business.

According to the New York Times, Paulson essentially told the banking executives they would have to accept the government investment for the good of the American financial system. In addition to the stock purchases, the FDIC will temporarily provide insurance for loans between banks for three years.

Neel Kashkari is overseeing the bailout.

"Our toolkit is being designed to help financial institutions of all sizes so they can grow stronger and provide crucial funding to our economy," says Neel Kashkari, Interim Assistant Treasury Secretary.

The unprecedented government response brought confidence back to Wall Street, at least for the time being. The Dow jumped 11 percent, but economists warn the government's plan is only a short-term boost and banks still need to clean up their books.

"The long term problem is a crisis in trust. Most lenders and most investors simply don't know that they can trust the numbers on pieces of paper," says Professor Robert Reich, from U.C. Berkeley's Goldman School of Public Policy.

President Bush is scheduled to be briefed Tuesday morning by his economic advisers. Shortly after, he will announce the plan.


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