US Outlines New Initiatives To Unfreeze Credit Markets

The US government outlined three new initiatives to aid financial institutions amid a historic credit crunch that has frozen lending around the world.

The moves fundamentally change the nation's historic hands-off relationship between government and the private sector.

• How the Revised Plan Will Work

The latest plan calls for a recapitalization of banks, federal guarantees on new bank debt for three years and FDIC insurance for non-interest bearing accounts, mirroring measures taken by other members of the Group of Seven nations.

In a news conference Tuesday, Treasury Secretary Henry Paulson said government stakes in private businesses was objectionable, but there was little choice in the matter.

"We regret having to take these actions," Paulson said. " Today's actions are not what we ever wanted to do. B ut today's actions are what we must do to restore confidence to our financial system."

Under the plan, the US government would take $25 billion in preferred stock in Bank of America , Wells Fargo , Citigroup , JPMorgan Chase , Goldman Sachs , Morgan Stanley and Bank of New York , State Street and Merrill Lynch .

Paulson said the banks— described as "healthy institutions"—had agreed to accept government stakes to help protect the U.S. economy.

The $250 billion will come from a $700 billion financial bailout program that was originally approved by Congress to buy bad assets that were poisoning bank balance sheets, paralyzing lending and threatening many institutions with failure.

Financial firms that turn to the government under the program will have to accept limits on executive compensation, including forfeiting tax deductibility for compensation above $500,000 for top executives.

The preferred shares also will pay cumulative annual dividend rate of 5 percent for the first five years and 9 percent after that, the Treasury said.

Revised Rescue Plan at a Glance

• US Treasury will buy up to $250 billion in senior preferred, nonvoting shares in financial institutions.
• Maximum purchase will be $25 billion per institution.
• Nov 14 deadline for banks to participate in equity purchase program.
• Preferred shares to pay 5 percent a year for first 5 years, 9 percent after 5 years.
• Firms in program must adopt Treasury's standards on executive pay and corporate governance.
• Compensation for top execs won't be tax deductible above $500,000.

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The recapitalization plan is a a dramatic change in strategy, which was originally based on a auction plan to buy bad debt from banks, and reflects the decision of G7 members to coalesce around a British proposal at a series of meetings in Washington last weekend.

"This is certainly an admission that the TARP [auction] was taking too long." said Robert Brusca, chief economist at FAO Economics.

Britain's bank plan called for 37 billion pounds ($64 billion) of taxpayers' cash to recapitalize three major banks in a move that could make the government their main shareholder.

Paulson was joined at Tuesday's news conference by Federal Reserve Chairman Ben Bernanke and FDIC Chairwoman Sheila Bair.

Bernanke offered no details about the federal guarantees, instead underscoring the central bank's recent decision to offer a backstop for the commercial paper market. Bernanke said the facility would start Oct. 27.

Blair did offer details of the guarantee plan, what she called a temporary liquidity guarantee program. The first aspect will guarantee senior unsecured debt and expires at the end of June 2009. The second aspect is directed at guaranteeing deposits, covering such things as company payrolls. Participants will be required to pay fees after the first 30 days.

Earlier Tuesday, President Bush called the initiatives "unprecedented steps" as part of a "coordinated plan of action."

"Each of these new programs contains safeguards to protect the taxpayers," said Bush. "The government's role will be limited and temporary."

Though the bulk of the efforts are directed at financial institutions, Bush made sure to mention that the moves would also help retirement accounts, college savings and small business.

Market watchers applauded the measures, even though critics say the size of the recapitalization plan may be a bit small given the size of the industry and its astronomical amount of outstanding debt.

"The banking system is the heart of any market economy," said Mohammed El-Erian, Pico Co-CEO. "You need to stabilize it." He added the plan will help banks "be able to lend again."

Princeton University professor and Nobel Prize-winning economist Paul Krugman told CNBC that for the first time he felt policy was "getting some traction on the crisis." Still, he called for more steps, including aid to state and local governments, public spending and measures to get "people spending."

The US banking industry measures follows pledges of more than 1 trillion euros ($1.36 trillion) by the governments of Britain, Germany, France and other European countries to bolster their banks.

Japan's government also announced a series of steps on Tuesday that could include a law allowing it to inject public funds into regional banks.

Many countries have also moved to reassure savers by guaranteeing bank deposits, which prompted the US to drop its initial reluctance to the idea.

—Reuters contributed to this report.

© 2008 CNBC