Paulson: Economy will improve, challenges remain

[October 15, 2008]  WASHINGTON (AP) -- Confidence and cash will restore the economy's health, but it will take time and patience, too, Treasury Secretary Henry Paulson said Wednesday.

A day after announcing a $250 billion cash infusion into the nation's banks in return for a stake in those institutions, Paulson said the plan should stabilize the system, induce banks to lend again, and -- eventually -- help improve the economy.

"This will take time. There will be challenges," he told a worried country.

The secretary was interviewed on ABC's "Good Morning America." He acknowledged that he initially opposed government intervention into the banking industry but that new facts changed the circumstances in recent days.

Paulson said, "There's no doubt that the way to get the maximum bang for the taxpayers here was to invest in banks."

He said he was more confident the system would right itself because of the steps the U.S. and other countries had taken recently to pry open locked lending that has stifled the global economy.

U.S. stocks appeared headed for a mixed opening, despite the plan, as investors turned their gaze toward the hurdles the economy faces: vanishing jobs, shrinking paychecks and nest eggs, and slumping home values continue to force millions of Americans to pull back.

Sales at the nation's retailers are expected to drop in September even as they get a break from record-high energy prices. Uncertainty about the economy -- and their own financial fortunes -- probably will force consumers and businesses alike to hunker down further, spelling more problems for the already troubled economy.

Anxiety about the economy is the No. 1 concern of voters. With the presidential election just weeks away, Democrat Barack Obama and Republican rival John McCain are working furiously to convince people that each is the best choice to steer the economy through these perilous times.

In addition to September retail sales numbers, other economic data out Wednesday is expected to show that even though the recent retreat in energy prices calmed inflation at the wholesale level bit, costs are still high and are squeezing businesses.

Many economists believe the country is on the edge of -- or already in -- its first recession since 2001.

If the government's new plan works -- it will merely cushion the blow. Democrats on Capitol Hill are pushing for another round of stimulus that could cost as much as $150 billion, an effort to provide additional relief and lift the country out of the doldrums.

Federal Reserve Chairman Ben Bernanke will provide an up-to-date assessment of the country's economic and financial challenges in a speech in New York on Wednesday.

Paulson said the plan is a major step towards restoring confidence in the banking system. "Doing this is the most important thing we can do for our economy," he said.

Big banks started falling in line Tuesday behind the rejiggered bailout plan.

But there was a mix of hope and skepticism on whether it would work. Unprecedented steps recently taken -- including hefty interest rate reductions by the Federal Reserve and other major central banks in a coordinated assault just last week -- have failed to break through the credit clog and the panicky mind-set gripping investors on Wall Street and around the globe.

Initially the U.S. government will pour $125 billion into nine major banks with the hope that they will use the money to rebuild their reserves and to increase lending to consumers and businesses. Another $125 billion will be made available this year to other banks -- if they need it -- for cash infusions.

In return, the government will get ownership stakes in the financial institutions. Banks, meanwhile, will have to accept limitations on executives' compensation.

"Government owning a stake in any private U.S. company is objectionable to most Americans -- me included," Treasury Secretary Henry Paulson said in announcing the initiative. "Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable."

The government is counting on banks not to just clutch onto the cash, which aggravated the credit crisis to begin with.

"The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it," Paulson said.

Treasury switched gears, deciding to first use a chunk of the $700 billion from the recently enacted financial bailout package to pay for taking partial ownership stakes in banks, rather than using the money to buy rotten debts from financial institutions. The government said it still intends to buy the bad mortgages and other toxic assets, another move aimed at getting credit flowing again.

Besides the $250 billion this year on the stock purchases, Bush said Tuesday that an additional $100 billion would be needed in connection with covering bad assets. That would leave $350 billion of the $700 billion program, presumably to be spent by the next president.

Economists as well as both Democratic and Republican lawmakers on Capitol Hill had urged Treasury to first move forward on the capital injection plan, arguing that was a more effective way to battle the financial crisis.

The first bank to take advantage of the program was Bank of New York Mellon which announced it would sell $3 billion in preferred shares to the Treasury. Other banks initially participating include Goldman Sachs Group Inc., Morgan Stanley, JPMorgan Chase, Bank of America Corp., including the soon-to-acquired Merrill Lynch, Citigroup Inc., Wells Fargo & Co., and State Street Corp.

The government's cash infusions are attractive to banks because they are having trouble getting money from elsewhere. Skittish investors have cut them off, moving their money into safer Treasury securities. Financial institutions are hoarding whatever cash they have rather than lending it to each other or customers.

Two other initiatives also were unveiled to stem the credit crisis: The Federal Deposit Insurance Corp. launched an insurance fund to temporarily guarantee new issues of bank debt -- fully protecting the money even if the institution fails.

And, the FDIC will start providing unlimited deposit insurance for non-interest-bearing accounts, which are mainly used by businesses to cover payrolls and other expenses. Frequently these accounts exceed the current $250,000 insurance limit, so the expanded insurance should discourage nervous companies from pulling their money out. Both of these efforts would be financed by fees charged to participating financial institutions -- not money from the bailout package.

[Associated Press; By JEANNINE AVERSA]

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