To put it as simply as I can, it has two major components: the government will spend 250 billion dollars to buy shares of stock in the most important banks. That will effectively flood the banks with cash and hopefully allow them to start lending money once again.
Remember, as I explained yesterday, the big story with the financial crisis isn't so much the stock market as it is the credit markets. Lending and borrowing money among the big banks like Bank of America, Goldman Sachs, Morgan Stanley, Citigroup and Wells Fargo, is the engine that drives our economy. Those credit markets have been frozen.
The plan announced today is designed to loosen those markets up. It may take months or even years for lending practices to return to normal levels, but it must start somewhere.
Not only will the government buy shares of stock from the banks, the FDIC will temporarily guarantee most new debt issued by insured banks. The FDIC will also expand its insurance program to cover all non-interest bearing accounts. Those are the accounts used by small businesses to cover daily transactions. These moves are temporary, but that could mean up to three years.
The idea is that after the banks return to profitability, they will buy back the stock from the government. The banks will also pay the government a 5% dividend, not great, but if it means averting a depression, not bad.
This plan is generally getting good reviews, even from economists who slammed the idea of the government buying up the banks' bad mortgages, those evil investments that were, in large part, responsible for this financial mess in the first place.
As one economist said today, "goodbye depression, hello recession." In a world where everything is relative, that's a positive statement. But that same economist wondered "why the heck didn't we get here sooner?"
There does seem to be a consensus of opinion out there that the Bush Administration, specifically Treasury Secretary, Henry Paulson, and Fed Chief, Ben Bernanke, have been trying to put out fires as they erupt, and until now, they've been ineffective despite the enormity of their efforts. So why this plan now?
One theory is that the United States was actually pressured into this "nationalization" of the banks by its peers in Europe. It apparently came to a head at the G-7 talks last weekend when everyone got together to come up with a world-wide effort to solve a world-wide crisis.
Nationalization, that's when a government takes control or partial control of a private company or industry, is more easily swallowed by the Europeans than by Americans. It certainly runs counter to the American ideals of free enterprise. But it's certainly not without precedent in this country. Here's a bit of history from the pages of the International Herald Tribune:
In times of war and national emergency, Washington has not hesitated. In 1917, the government seized the railroads to make sure goods, armaments and troops moved smoothly in the interests of national defense during World War I. Bondholders and stockholders were compensated, and railroads were returned to private ownership in 1920, after the war ended.
During World War II, Washington seized dozens of companies including railroads, coal mines and, briefly, the Montgomery Ward department store chain. In 1952, President Harry Truman seized 88 steel mills across the country, asserting that unyielding owners were determined to provoke an industry-wide strike that would cripple the Korean War effort. That forced nationalization did not last long, since the Supreme Court ruled the action an unconstitutional abuse of presidential power.
In banking, the U.S. government stepped in to take an 80 percent stake in the Continental Illinois National Bank and Trust in 1984. Continental Illinois failed in part because of bad oil-patch loans in Oklahoma and Texas. As one of the country's top 10 banks, Continental Illinois was deemed "too big to fail" by regulators, who feared wider turmoil in the financial markets. Continental was sold to Bank of America in 1994.
Yet the nearest precedent for the plan the Treasury is weighing, finance experts say, is the investments made by the Reconstruction Finance Corporation in the 1930s. The agency, established in 1932, not only made loans to distressed banks but also bought stock in 6,000 banks, at a total cost of about $3 billion, said Richard Sylla, an economist and financial historian at the Stern School of Business at New York University.
It's interesting to note that attempts to nationalize private industries, both successfully and unsuccessfully, have come either as a result of the Depression or in times of war. That should tell you how serious this all is. If it provides any comfort to capitalists, who, whether we know it or not, most of us are, all of the examples above show that the Federal Government is anxious to get historically private companies and industries back exclusively in the private sector as quickly as possible. There's no reason to think that won't happen this time too.
So if this plan to directly pump so much money into the banking system is such a good idea, why did Wall Street first go way up today, then way down and finally end up down 76 points?
Ha! If I knew that...