US may buy shares in troubled banks, Paulson says

After the Emergency Economic Stabilisation Act was passed last week, attention focused on the promise of up to $700 billion investment by the Treasury in illiquid assets held by financial institutions. But yesterday Paulson reminded a press conference the act had given him other powers as well.

"The EESA adds broad, flexible authorities for Treasury to buy or insure troubled assets, provide guarantees, and inject capital. We will use all of the tools we've been given," he said, "including strengthening the capitalization of financial institutions of every size".

During the House debate on the EESA on October 3, US congressmen emphasised they wanted the Treasury Department to have the power to buy bank stock as well as assets. Jim Moran, a Democratic congressman from Virginia, said: "The intent of this legislation is to authorize the Treasury Department to strengthen credit markets by infusing capital into weak institutions in two ways: by buying their stock, debt, or other capital instruments; and by purchasing bad assets from the institutions".

The UK bailout, announced yesterday, would see the government invest up to £50 billion in UK banks, in exchange for preferred shares. By contrast, the US plan centres around investing in bank assets - first illiquid assets such as mortgage backed securities, and subsequently commercial paper - and attracted criticism from many economists for apparently neglecting the option of buying bank equity instead.

"Purchasing toxic/illiquid assets of the financial system is not the most effective and efficient way to recapitalize the banking system," commented New York University's Nouriel Roubini on September 28. "In the Scandinavian banking crises (Sweden, Norway, Finland) that are a model of how a banking crisis should be resolved, there was no government purchase of bad assets; most of the recapitalization occurred through various injections of public capital in the banking system. Purchase of toxic assets instead – in most cases in which it was used – made the fiscal cost of the crisis much higher and expensive."

See also: UK government unveils £50 billion bank recapitalisation plan
Federal Reserve to buy commercial paper from US banks
Hope for markets as Senate rescues bailout