According to this NYT article, the Treasury is considering making capital investments in banks using the authority granted in the TARP:

WASHINGTON — Having tried without success to unlock frozen credit markets, the Treasury Department is considering taking ownership stakes in many United States banks to try to restore confidence in the financial system, according to government officials.

Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it. Such a move would quickly strengthen banks’ balance sheets and, officials hope, persuade them to resume lending. In return, the law gives the Treasury the right to take ownership positions in banks, including healthy ones.

I hate the idea of government ownership of banks or any private company. When government and business get together the only thing that is sure is that the taxpayer is about to get screwed. Exhibit 1 would be Fannie Mae, exhibit 2 Freddie Mac. On the other hand, injecting capital directly in the banks would probably end up being a better deal for the taxpayer than buying a bunch of toxic mortgage paper the value of which no one knows.  Would it end the credit crunch? That depends on what the banks do with the new capital. If they stay risk averse and just buy some Treasuries, we won’t have accomplished much.

This plan is no panacea however and it is unlikely to solve the entire problem. The problem in credit markets right now is a lack of information. No one will lend to banks because they don’t know which ones are really in trouble. Until that problem is solved, they will continue to be wary. There is only one way to do that – the bad banks need to fail. The FDIC and Treasury have the ability to handle this situation; the WAMU/JPM deal didn’t cost the taxpayer anything and if Wells Fargo wins, the Wachovia deal won’t either. That is how these things should be done. The only ones hurt are the investors in the bad banks.

Paulson and Bernanke seem to be sneaking up on a solution to the credit crunch. TARP rev. 2 is better than version 1. Even a blind squirrel finds a nut once in a while.

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