Bank rescue closes door on a free-wheeling era

A swing toward deregulation that began with the Reagan years comes crashing to a halt

WASHINGTON -- When the sun set on the nation's capital Tuesday, it marked the end of one era in the nation's political economy and the beginning of another. American taxpayers had become partial owners of the nation's nine leading banks, with more to come.

The Bush administration's announcement that it would take ownership stakes in private banks marked a momentous shift away from a 30-year effort to get government out of business's way and opened the door to a new era of government engagement with business in ways that are only starting to unfold.

Although it's a move away from laissez-faire capitalism, it's far short of nationalization. While the government is now to be a partial owner of banks, it isn't taking over their management. The joint ownership is expected to be temporary, perhaps three to five years, and once the banks regain stability and profitability, the government intends to sell its shares in the hope of earning taxpayers a profit.

Rather than a wholesale switch from free-market capitalism to socialism, then, what's going on is instead a swing of the pendulum in the relationship between regulation and the market that's been evolving at least since Franklin D. Roosevelt's New Deal of the 1930s.

The evolution this time is toward stronger government and more regulated markets. Since the start of the Reagan Revolution in 1981, the pendulum had swung the other way.

Now government and bankers will be limited partners -- and strange bedfellows.

When the federal government seized savings and loans in the 1980s, or when it took bank stakes during the Great Depression of the 1930s, it did so because they were insolvent. Tuesday's partial bank purchases were instead an attempt to thaw credit markets that had frozen amid a loss of confidence in lending of all sorts. It was a bid to change market psychology.

"Today's actions are not what we ever wanted to do, but today's actions are what we must do to restore confidence to our financial system," Treasury Secretary Henry Paulson said in announcing plans to invest $125 billion in nine U.S. banks: Bank of America, including Merrill Lynch separately, as well as Citigroup, Bank of New York Mellon, Goldman Sachs, J.P. Morgan Chase, Morgan Stanley, State Street and Wells Fargo.

Paulson set aside another $125 billion to invest in hundreds, perhaps thousands, of other banks through mid-November. All told, more than a third of the $700 billion that Congress authorized weeks ago to purchase distressed assets from banks now will be used to give banks the equivalent of a flu shot against a nasty financial virus.

Will it work?

The verdict on the Bush plan will be visible first in what happens in coming weeks to obscure indicators such as overseas rates for lending in dollars and the spread, or gap, between these rates and those for safe investments, led by Treasury bonds. But the real measure of success will be how fast banks resume lending and businesses return to vitality. Most economists think that the United States is in a recession; the question is how deep and how long it will be. The answer probably won't be known before spring.

"More timely action would have been better, but it is now coming and in international coordination -- a plus," said R. Glenn Hubbard, the dean of Columbia University's Graduate School of Business and the chairman of President Bush's Council of Economic Advisers from 2001 to 2003.

The new Bush plan won't give taxpayers a controlling stake or voting rights in affected banks, nor any apparent way to influence the makeup of a bank's board of directors.