Progress Amid the Ruins

Some capital steps in London, and (maybe) at the U.S. Treasury.

It may not look like it amid the wild markets, but the world’s political leaders are making progress against the global financial panic. The biggest problem continues to be that no one in authority seems able to explain what is happening and why, so all of this feverish government action is scaring everyone to death.

[Progress Amid the Ruins] AP

The world is nonetheless making intellectual strides, not least in London with yesterday’s announcement that the British government will inject up to £50 billion into eight major banks and others that may qualify. France also said it will set up a legal body so the state can intervene swiftly to take stakes in banks that run into trouble. And late Tuesday, the Spanish government said it will set aside a €30 billion fund, which may increase to €50 billion, to buy illiquid but healthy assets.

The London move goes to the heart of the problem, which is the capital hole in the financial system that is fueling the global panic. Private capital won’t fill that hole with fear so rampant, so some public capital is going to have to serve as a temporary life preserver — in the U.S. and Europe.

The U.K. government plans to inject up to £50 billion in return for preferred shares — giving taxpayers some upside once the panic passes. London will further guarantee £250 billion in new debt issuance for those banks that participate in the recapitalization plan in order to secure their short- and medium-term funding. Britain has thus helped to shore up its own banks, moving beyond the ad hoc crisis management after individual bank failures.

Meanwhile, in the U.S., Treasury Secretary Hank Paulson signaled that his new rescue power includes the ability to do something similar. “It is the policy of the federal government to use all resources at its disposal to make our financial system stronger,” Mr. Paulson said, “including strengthening the capitalization of financial institutions of every size.”

We take — and hope — that this means Mr. Paulson is willing to use some of his new $700 billion Troubled Asset Relief Program (Tarp) to inject capital into individual banks if needed to prevent failures. Treasury would still move ahead with its auctions to purchase toxic bank securities, but amid a panic more urgent action may be necessary. Mr. Paulson is right to interpret his mandate broadly, and to show that he is willing to use it. In essence, he is saying the Tarp could be used as a larger, better capitalized version of the Federal Deposit Insurance Corp., injecting capital into banks in return for preferred stock to protect the taxpayer. This is a policy breakthrough.

Some in the media — especially the Brits — can’t resist calling these capital injections a “partial nationalization.” Perhaps this is nostalgia for the heyday of Fabian socialism. But while the size of this intervention is unusual, the U.S. has acted to rescue the banking system at other times since the Great Depression. Think of the savings and loan debacle in the late 1980s, as well as the collapse of the oil patch and the failure of Continental Illinois earlier that decade. The government that helped to create the mess has to play a role in cleaning it up.

These interventions are, or at least should be, temporary efforts to stabilize and rebuild the banking system and thus avoid a more costly financial crash. There is always a danger that politicians will want to start allocating credit for their own purposes (see Fannie Mae and Freddie Mac), so it is imperative that governments return any bank shares they accumulate back to private hands once the crisis passes. As bank stocks recover, the taxpayers might even see a profit on their preferred shares.

Also yesterday, the world’s main central banks announced a coordinated 50-basis-point interest rate cut. The best part of this was its coordination, involving the Federal Reserve, the European Central Bank, the Bank of England and the central banks of Canada, Switzerland and Sweden. China got into the act later. By acting in concert, the banks showed common purpose and avoided the mistake of the last year when the Fed cut rates in pell-mell fashion and sent the dollar reeling and commodity prices soaring. Turmoil in currency markets is the last thing the world needs now.

With so much frenetic action, it’s no wonder the world’s investors and even average savers are heading for safety. All the more so when there isn’t a Ronald Reagan or Paul Volcker who commands confidence on the world stage. President Bush has tried to reassure and deserves credit for pushing Tarp through Congress, but he’s lost his ability to persuade the public. Mr. Paulson and Fed Chairman Ben Bernanke must rebuild their credibility after their mistakes of the last year. Meanwhile, John McCain and Barack Obama are both playing their familiar political tunes, which are largely beside the point.

Amid all of this, and despite the tumultuous markets, we are better off than we were a week ago. On present trends, we might avoid a crash after all.

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