U.S., Bowing to Pressure, Will Buy Banks

BOSTON, Oct 11 -- The George W. Bush administration announced Friday evening it would buy shares in troubled U.S. banks, a move that upstages its own rigid, free-market ideology, and answers calls for the action by European leaders.

Until now, the U.S. has resisted taking the action even though doing so would be a prudent plan for stabilizing financial institutions, said Thomas Palley, founder of Economics for Democratic and Open Societies.

"What you are really seeing is how ideology can get in the way of good policy. Republicans have been averse to gaining an equity stake in the banks," Palley told IPS.

U.S. Treasury Secretary Henry Paulson made the announcement following a meeting with the finance ministers of the G7 richest nations, who said "urgent and exceptional action" is needed. The governments issued a brief, five-point plan for stabilizing markets, including allowing banks to raise capital from public and private sources as necessary.

"It is aimed at recapitalizing the financial institutions in the U.S.," Paulson said. "We want to do this as soon as possible but we want it to be right and to be effective."

"This is a period like none of us has ever seen before," he told reporters. On Saturday, G20 finance ministers are meeting with Pres. Bush.

The week was marked by severe turmoil in markets throughout the world, especially in Iceland, Indonesia, Pakistan, Romania, Russia and Ukraine.

In the U.S., an auction Friday of risky investments held by Lehman Brothers, which declared bankruptcy, were sold for 8.625 cents on the dollar.

Britain unveiled a plan to inject up to 87 billion dollars into its banks, and it has been urging other nations to do the same.

"In Britain, there is no such political obstruction, so they went ahead," Palley said. "British Prime Minister Gordon Brown will be a political beneficiary of his courageous action."

On Wednesday, in an effort to free up lending among big banks, the U.S. Federal Reserve and central banks in Europe coordinated an interest rate cut. But European nations have otherwise acted singly, with each tackling their troubled markets with any of a variety of measures to free up lending and shore up banks. According to the G7 statement, they will continue to act on their own.

"Each of the 27 European Union markets have different ways of banking," said Christine Lagarde, France's finance minister, while in Washington Thursday. "As a result, obviously we deal with issues in different ways. If you look at the Danish market it has 140 banks. Sweden has 14 banks," she said.

Paulson said the U.S. will use part of 700 billion dollars allocated by Congress on Oct. 3, to buy non-voting shares, also called recapitalization, in banks and other struggling U.S. institutions.

The purchases mean that U.S. taxpayers will own part of the banks. It is a necessary step, Lagarde said.

"Recapitalization, however strange it may seem for countries that are more free market, is one of the key tools that will be used," she said.

The global wildfire in the world's markets is widely believed to have started in the U.S. after financial institutions created a new type of investment product made from bundles of unrelated mortgages, including a significant number of mortgages that were high risk and likely to go into default.

Many of the risky mortgages had very unfavorable terms and were aggressively peddled to unsuspecting consumers in the U.S. and elsewhere. Now, millions of people are defaulting on their mortgages. Banks throughout the world invested in the risky mortgage products.

"The financial crisis has reached a critical point. The sharp decline in the stock market and its volatility dramatically make the point. More important if less visible, the flow of credit through the banking system and the financial markets is seriously impaired, even in part frozen," said Paul Voelker, former chairman of the Federal Reserve, in a letter in the Wall Street Journal Friday.