Paulson's $250 Billion Bank Buy

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"The actions today are aimed at restoring confidence in our institutions and markets and repairing their capacity to meet the credit needs of American households and businesses," said Fed Chairman Bernanke in a prepared statement. "The voluntary equity purchase program will strengthen financial institutions' capacity and willingness to lend. The guarantee of the senior debt of all FDIC-insured depository institutions and their holding companies will restore the confidence of these institutions' creditors and reinvigorate the crucial inter-bank lending markets. Additionally, the Federal Reserve is pressing forward with its facility to provide a broad backstop for the commercial paper market, so vital to the functioning of our businesses."

The cumulative moves represent a big shift from just two weeks ago, when Congress and Treasury agreed that the rescue package would focus largely (BusinessWeek.com, 10/3/08) on buying up troubled mortgage-related assets from banks and other institutions. But as the Standard & Poor's 500-stock index tumbled 22% last week—its second-worst one-week performance ever (BusinessWeek.com, 10/10/08)—it rapidly became clear that investors had little faith that asset purchases alone would shore up the industry. Over the weekend the European Union also moved to broadly guarantee lending between banks; Britain and other nations have also moved to take equity stakes in their own banks.

Treasury's expected moves mirror what Europe has done (BusinessWeek.com, 10/13/08), though they are slightly different in detail. "Other countries have skipped the asset-purchase stage altogether and moved directly on to investing in their banks and guaranteeing their deposits," says Bert Ely, who runs Ely & Co., a financial-services consultant. "A lot of the issue is simply resolving the short-term [funding] problems; many banks aren't insolvent. We need to stabilize them first, then we can sort through which institutions are healthy enough to survive."

That, of course, will raise plenty of thorny issues. Few expect the government to invest indiscriminately, and Treasury and other regulators are now essentially in the position of deciding which of the thousands of banks in the U.S. will survive and which are goners. That enormous power raises big questions, both economically and politically.

Rock and a Hard Place

Certainly, many see it as a prudent position—as Campbell Harvey, a Duke University business professor, puts it: "You don't want to throw the good money at the bad." But it also leads some to oppose government investment in the first place—particularly since Treasury has given little indication of what criteria it will use to perform that triage.

"I just think it's a bad idea," said John Douglas, a former FDIC general counsel and chair of the banking and financial institutions group in the Atlanta office of law firm Paul, Hastings, Janofsky & Walker. "For the government to look at that list of 8,000 [banks and thrifts] and say: 'I'm going to save you and not you'—that's tough."

Moreover, by investing in some banks and not others, the government could give those in which it invested a market advantage. Even unsupported banks that survive could find themselves losing business to those that are as borrowers and depositors favor institutions that have the government's backing.

But given the sector's overwhelming problems and the risks to the global economy of a failure to stem the credit crisis, that's a risk Paulson and his fellow regulators are resigned to taking.

Sasseen is Washington bureau chief for BusinessWeek. Francis is a correspondent in BusinessWeek's Washington bureau.