“From the first days of negotiations on the Emergency Economic Stabilization Act, Congress demonstrated bipartisan support for direct injections of capital into troubled financial institutions, even though the administration’s preferred approach was primarily to purchase troubled assets,” said Pelosi in a statement.
Paulson’s newest proposal mirrors one suggested by Soros, a major Democratic financial backer who proposed establishing a financial reconstruction corporation to buy $500 billion worth of equity capital in inadequately capitalized banks.
While Paulson elected to purchase only $250 billion worth of equity, he adopted Soros’s idea of the government buying stakes in the form of non-voting preferred shares with a low fixed interest rate and warrants or options to buy common stock.
Conservative Republicans were highly skeptical of this proposal two weeks ago.
“You’re talking about nationalizing all the banks,” said Sen. Tom Coburn (R-Okla.) when asked about government purchasing equity in banks before the congressional recess.
Blunt stressed that the government stake would be in the form of non-voting shares and emphasized the U.S. intervention would be on a much smaller scale compared to actions by European governments.
“This is nowhere close to the nationalization effort made in Europe,” Blunt said, noting that the U.S. will buy a lower-percentage stake. “We aren’t nationalizing the banks like the Europeans did.”
Barry Bosworth, a senior economist at the Brookings Institution, said it would be more accurate to think of the proposed government aid as loans or “debt instruments” instead of equity purchases because they have fixed interest rates and lack the earning potential of regular stocks. Bosworth also said that the government would not likely hold its stakes beyond five years, after which the interest rates would jump significantly, giving banks strong incentive to buy back the preferred stock.
J.D. Foster, an expert in fiscal policy at the conservative Heritage Foundation, said the prohibition on the government exercising voting power over its equity stakes would safeguard against the government gaining too much control over the financial markets.
Nevertheless, he said the plan sets a worrisome precedent for future market freedom.
Foster said the amount of taxpayer dollars being put at risk and the strenuous government effort to sustain the markets makes greater federal influence on private sector management decisions “unavoidable.”
“The concern is the precedent for government dictating management decisions in calmer times,” he said.
J. Taylor Rushing contributed to this article.
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