Banks move splits GOP, right wing

A dramatic shift in the Bush administration’s economic rescue to purchase preferred stock in the nation’s banks has received cautious approval from congressional leaders while sparking anger among some conservatives.

Democratic leaders praised Treasury Secretary Henry Paulson’s newest plan, which resembled an idea circulated on Capitol Hill earlier this month by billionaire financier George Soros. Under Paulson’s proposal, Treasury would invest $250 billion in banks to help them begin lending again and in return would receive preferred stock and warrants for common stock.

{mosads}The investments would give the federal government as much as a 20 percent stake in the nation’s largest banks, although several experts said the ownership positions would likely end within a period of five years.

Some Republicans slammed Paulson for taking a major step toward socializing the American financial system.

“When a private asset is purchased by the government, it is an asset that has been socialized,” said Rep. Thaddeus McCotter (Mich.), chairman of the House Republican Policy Committee and a member of the Financial Services Committee.

But other GOP leaders said Tuesday that Paulson’s plan included safeguards against government control of banks because its stake would be in the form of non-voting shares.

“The government won’t be running the banks, but making an investment,” said House Republican Whip Roy Blunt (Mo.).

The split in the party comes as some members question the cost of bailing out banks that took costly risks.

Some say the move calls to mind earlier government takeovers, such as Britain’s nationalization of its coal industry in the 1940s and its airline industry in the 1970s.

“It stinks,” said Andy Roth, the director of government affairs at the Club for Growth, a conservative advocacy group that promotes smaller government and lower taxes.

“What’s astonishing is that the administration is a Republican administration and their bedrock principle is supposed to be tax cuts. They’re picking socialism over pro-growth tax cuts. It shows how far we’ve come as a party.”

Democratic leaders applauded the move, whereby the federal government would buy $25 billion of preferred stock in Citigroup, Bank of America, JPMorgan Chase, and Wells Fargo, giving Uncle Sam between 15 percent and 55 percent of those firms’ shareholder equity. Treasury would buy $10 billion stakes in Goldman Sachs and Morgan Stanley. It would spend $125 billion for shares in thousands of smaller banks.

“After weeks of turmoil in the financial markets, I am pleased that the administration is now acting more aggressively to address this crisis,” said Senate Majority Leader Harry Reid (D-Nev.).

House Speaker Nancy Pelosi (D-Calif.) said that Democrats had first pushed for a direct injection of capital into the banking system through equity purchases but were rebuffed by Paulson.

{mospagebreak}“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.

{mosads}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.