ALL BUSINESS: Another fix for the financial crisis

By RACHEL BECK, AP Business Writer 1 hour, 37 minutes ago

NEW YORK - Three weeks ago, Treasury Secretary Henry Paulson called the notion that the government would buy stakes in banks to save them a "failure."

What a difference 21 days and $2.4 trillion dollars in lost value from pension funds, college funds and 401(k)s makes.

For more than a year, U.S. officials haven't been able to get this financial mess under control, and their constant fumbling has wrecked the public's confidence.

The government's plan to take partial ownership of banks is just the latest round of flip-flopping on the part of the Bush administration. Let's hope they have it right this time.

Compare this: "Some said we should just stick capital in the banks, take preferred stock in the banks," Paulson told the Senate Banking Committee on Sept. 23. "Putting capital in institutions is about failure. This is about success."

With this: "Today's actions are not what we ever wanted to do — but today's actions are what we must do to restore confidence in our financial system," Paulson said Tuesday when he announced the new plan.

This crisis began with the housing market collapse, but has ballooned into something bigger and more complicated than anyone, even Paulson, ever thought it would be.

"We are acting with unprecedented speed taking unprecedented measures that we never thought would be necessary," Paulson said with Federal Reserve Chairman Ben Bernanke and Federal Deposit Insurance Corp. Chairman Sheila Bair at his side.

But the Bush administration's massive missteps have only compounded the current woes. First, officials said the mess would be "contained." Then it took them months to acknowledge its severity. And once they decided to fight it, they've struggled to find the right medicine.

"In the 'fog of war,' it is often hard to see the best way to move forward," said Ed Yardeni, who runs an investment firm bearing his name. "Policy mistakes, which worsen the conflict, are always made."

What's most troubling is that there has been a slew of plans meant to rescue the financial system, and each has been billed as the one that would attack the root cause of the problem.

Just look at what has happened since Labor Day. The government has taken over the nation's two biggest mortgage finance firms, Fannie Mae and Freddie Mac, rescued American International Group, the world's biggest insurance company, and won congressional approval of a $700 billion rescue package for the entire financial system.

Meanwhile, the Fed has taken all sorts of actions to pump liquidity into the marketplace.

Each was meant to soothe investors' nerves. Each only made them more anxious, culminating in a massive stock market rout last week that saw the Dow Jones industrial average lose more than 18 percent of its value — the worst weekly decline for the Dow ever.

In the meantime, the economy's health has deteriorated significantly and credit conditions have tightened further, so much so that in some corners of the market lending has essentially halted.

"The market 'panic' in the U.S. has — in substantial part — been whipped up by politicians and regulators to sell the plan of the day by fearful politicians," said Joseph Mason, professor of finance at Louisiana State University's E.J. Ourso College of Business. "The problem in markets right now is uncertainty and the now-common government interventions are creating more uncertainty."

Just days ago, the cornerstone of the $700 billion bailout bill was supposed to involve the Treasury buying bad assets, primarily mortgage-backed securities, from financial institutions. The goal would be to take the bad loans off of the books of banks, a move that would then encourage them to be more willing to return to normal lending operations.

Now, Paulson is advocating taking $250 billion of that $700 billion to make direct stock purchases in distressed financial institutions. That's supposed to give banks the capital infusion they need to stay solvent.

The first purchases of preferred stock will be in nine large banks, but the program is expected to be expanded to many others, according to details announced on Tuesday.

History says this action could work. A new International Monetary Fund paper that studied 42 banking crises in 37 countries from 1970 to 2007 found there was a faster recovery in gross domestic product and stock markets when equity injections were done over bad loan purchases.

It will take a long time to know whether this move is a success. The best gauge will come if the government can one day get taxpayers' money back by selling the bank shares at a profit.

For now, hopes have to be kept in check. Washington has disappointed before.

___

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org