Bank bailout: Everything you need to know

Why the Treasury's emergency infusion of dollars into banks just might work, and how you'll know if it does.

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
Interview by George Mannes, Money Magazine senior writer

(Money Magazine) -- On Oct. 14, the U.S. Treasury announced it would spend $250 billion of taxpayer money to buy shares in U.S. banks. The feds hope that the infusion will resolve the financial crisis paralyzing the economy. Here, in 300 words or less, is everything you need to know about it.

Why not the original $700 billion bailout plan? Because Treasury Secretary Hank Paulson's first idea - buying $700 billion of suspect loans that banks couldn't unload - didn't ease fears. The week after that plan became law, the S&P 500 dropped 18%. Investors were concerned that unless the Treasury wildly overpaid for the loans, it wouldn't save the banks, says University of Chicago economist Douglas Diamond.

Why do the feds think the cash infusion will work? Simple math. Because banks can make more than $10 worth of loans for every dollar of equity, a cash infusion makes a bigger splash than using that same money to lop off bad debt. Plus, the tactic has succeeded elsewhere: When banks tanked in Sweden in the early 1990s, the government bought up stock as part of an ultimately successful bailout.

What will be the final price for taxpayers? Unclear. "Before we can figure out what it's going to cost to do the surgery, we've got to stabilize the patient," says Frank W. Anderson, a longtime banking analyst who now teaches at the University of Texas at Dallas. The government hopes that the banks will repurchase the shares within five years, but since it will need to borrow to get the money for the investment, the national debt will rise. Still, letting lending freeze and bank failures run amok would likely be much costlier in the long run.

How will I know if the cash infusion is working? Look for a loosening of credit as seen in a decrease in the TED spread, a measure of the banks' trust in one another. A week after this plan was announced, the spread had fallen.  To top of page

Send feedback to Money Magazine
Features
They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
More Galleries
Cool cars from the LA Auto Show There are some of the standout vehicles on display this year at the Los Angeles Auto Show. More
American Dream homes: Prices in 10 cities How much does the American Dream home cost? From $2 million in Los Altos, Calif., to $65,000 in Cleveland, here's what you'll pay for a 4-bedroom, 2-bath house, according to Coldwell Banker's annual survey. More
FBI's 10 most wanted cyber criminals The FBI is raising the stakes in its hunt for hackers and cyber fraudsters. Meet the suspected cybercriminals the agency wants most. More

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.