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Federal bank buy-in no economic quick-fix

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JEANNINE AVERSA | October 15, 2008 12:44 AM EST | AP

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WASHINGTON — With any luck, the government's quarter-trillion dollar cash infusion in banks will get them lending again, but the radical move won't quickly turn around the tottering economy.

The pain will almost certainly drag on as 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.

Big banks started falling in line Tuesday behind the rejiggered bailout plan that will have the government forking over as much as $250 billion in exchange for partial ownership _ putting the world's bastion of capitalism and free markets squarely in the banking business.

Some early signs were hopeful for the latest in a flurry of radical efforts to save the nation's financial system: Credit was a bit easier to come by. And stocks were down but not alarmingly so after Monday's stratospheric leap.

The new plan, President Bush declared, is "not intended to take over the free market but to preserve it."

It's all about cash and confidence and persuading banks to lend money more freely again. Those are all critical ingredients to getting financial markets to function more normally and reviving the economy.

The big question: Will it work?

There was a mix of hope and skepticism on that front. 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.

The Dow Jones industrials declined 77 points on Tuesday after piling up their biggest point gain in history on Monday on news of Europe's rescue plan and in anticipation of the United States' new measures.

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."

Whether the $250 billion will be sufficient to encourage banks to lend again is hard to tell, said Anil Kashyap, professor of economics and finance at the University of Chicago's Graduate School of Business. The Treasury Department arrived at the $250 billion figure after consulting with banking regulators.

"This plan will work if we wind up with everybody pretty well capitalized," Kashyap said. "But if it doesn't reach that point, we'll be back in soup down the road."

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.

Even if the new plan works, economists caution that it could take years before locked up lending returns to normal.