Banks begin rush for US bailout funds

Early reluctance is giving way as hundreds prepare to apply before the deadline.

Badge of shame – or sign of solvency?

That's the question for thousands of banks across the US as they decide whether to apply for government investments from the Treasury's $700 billion rescue fund.

When Treasury Secretary Henry Paulson first announced that Washington would inject capital into private banks directly via equity purchases, some analysts thought that participation might mark regional institutions as somehow impaired.

But dozens of banks have already signed up, and hundreds more now are expected to follow by the mid-November deadline. That rush – plus the fact that the money represents reasonably priced capital – appears to have changed the equity program's image.

"There's some feeling this is a club you have to be a member of," says Robert Brusca, chief economist at Fact and Opinion Economics.

The Treasury's rescue effort already has changed and grown into something more complicated than officials envisioned when the bill authorizing it was signed into law by President Bush on Oct. 3.

Originally, the $700 billion was intended for government purchase of the toxic mortgage-based assets held by financial institutions. But as markets continued to deteriorate throughout October, the Treasury Department announced that $250 billion of the money would be used for direct injections of capital into banks, as a means of getting credit moving through the economy more quickly.

Since then, administration officials have announced that they may also draw on bailout bill authority to try to help prevent home foreclosures, perhaps by partially guaranteeing some refinanced mortgages.

That effort appears to have slowed, however, as officials discuss how to figure out which homeowners are deserving of government aid.

A homeowner who is struggling yet still making payments on time might feel slighted if a neighbor in similar circumstances gets a US subsidy, pointed out White House spokeswoman Dana Perino on Nov. 3.

"How do you deal with all of that? And we're mindful of it, and that's why we're taking some time," Ms. Perino said.

The Treasury also reportedly is considering direct investment in a range of firms that are involved in financial business, not just banks and insurance firms.

But the direct injection of funds for banks is the only part of the Treasury's effort so far. Officials have not detailed the methods used to evaluate applicants, lest those who don't meet the criteria be tainted. As of Tuesday, 35 institutions had said they would participate, accounting for some $163 billion of the Treasury's announced investment capital.

Hundreds more institutions have indicated interest in joining in, according to the Treasury. The question thus may be whether the US has allocated enough money to the effort – not whether it can cajole regional banks to get involved.

Combined with the actions being taken by the Federal Reserve, which include bolstering the short-term credit markets by direct purchase of commercial paper, the Treasury's bank effort is "huge," says Brian Bethune, chief economist at IHS Global Insight, an economic analysis and forecasting company in Lexington, Mass.

But the negative forces at work in the economy are also powerful, says Mr. Bethune. Thus, in terms of the nation's financial markets, "there's this massive battle going on," he says.

There are some signs that the Treasury effort is making progress. Lending between financial institutions has begun moving again, noted Phillip Swagel, assistant secretary of the Treasury for economic policy, in a statement released Monday.

The spread between three-month interbank loans and the risk-free three-month Treasury bill rate has begun to narrow, falling from a high of 457 basis points to about 260 basis points, said Mr. Swagel. But he added that this spread, known as the "TED spread," remains high by historical standards.

Prior to mid-2007, the TED spread averaged about 40 basis points.

"It will take time for financial markets to stabilize and for credit market strains to ease," concluded Swagel.

Lending to nonfinancial institutions remains tight. On Monday, the Federal Reserve said its latest quarterly survey of bank lending practices found high numbers of banks reporting tighter credit standards across a broad range of loan products.

Fully 95 percent of banks reported tighter standards for the lines of credit they extend to large and medium-size businesses, for instance. Sixty percent said they had tightened standards for consumer credit-card debt.

"The lending picture is very much a mess," says Mr. Brusca of Fact and Opinion Economics.

That mess can be seen in the drop in auto sales, for instance, according to Brusca. Overall auto sales fell 32 percent in October, compared with the same month last year. General Motors' sales fell 45 percent.

Many auto loans are made by financial arms of the auto industry to buyers without sterling credit. In the past, those loans were secured by the collateral of the vehicle itself. But given the overall weak market for cars and trucks, that collateral is no longer enough.

"Nobody wants to make those loans anymore," says Brusca.