World Governments Bail Out Banks

On October 14, 2008, the governments of Europe, Japan and the U.S. took unprecedented coordinated action to try and stem the ongoing global credit crisis. The European Union committed to spend $1.8 trillion to guarantee bank financing, buy shares to prevent banks from failing, and take any other steps needed to get banks to lend to each other again. This step was taken after the UK committed $88 billion to purchase shares in failing banks and $438 billion to guarantee loans. In a show of solidarity, the Bank of Japan agreed to lend unlimited dollars and suspend its bank stock selling program. In return, the EU is asking the U.S. to meet and increase banking regulation and increase the role of the IMF in this process. (Source: Bloomberg, BOJ Offers Unlimited Dollars to Banks, October 14, 2008; Bloomberg, Europe Push for Global Banking Rules, October 14, 2008)

In response to the global united front, the U.S. reversed its strategy and agreed to also purchase equity ownership in major banks, and spend less funds to purchase toxic mortgage debt. The Treasury Department will buy preferred shares of stock of Bank of New York Mellon, Goldman Sachs, J.P. Morgan, Morgan Stanley, Bank of America/Merrill Lynch, Citigroup, Wells Fargo, and State Street. In return, banks will limit executive compensation, and put the capital into circulation instead of hoarding it, as they have been.

The governments' shares require a 5% dividend that will increase to 9%, encouraging banks to buy the government out. Thus, the government will make a profit, as bank share prices should be higher then.

Treasury will use $250 billion of the $700 billion authorized in the Bank Bailout Bill, with $100 billion to be used to purchase toxic debt, the Bill's original purpose. The remaining $350 billion won't be used till next year. The plan to purchase equity instead of toxic debt was changed to align with European countries' plans to infuse companies immediately with capital, and not wait the few weeks needed until Treasury Asset Repurchase Program could be implemented.

In addition, the Federal Reserve will buy commercial debt starting October 27, 2008. Furthermore, the FDIC will insure both new issues of bank debt and existing business bank accounts, exceeding the current $250,000 limit. (Source: AP, Bailout Become Buyin as Feds Move Into Banking, October 14, 2008)

The action seemed to work, as LIBOR rates, which is what banks charge each other for three-month dollar loans, eased slightly to 4.64%, down from 4.82%. (Bloomberg, U.S. Stocks Fall, October 14, 2008)