U.S. to buy stakes in banks to fight credit crisis

WASHINGTON (Reuters) - Treasury Secretary Henry Paulson met with top Wall Street bankers on Monday to nail down a plan for the government to buy shares in financial firms to restore confidence in rattled markets.

The Wall Street Journal, citing people familiar with the matter, said the Treasury was expected to unveil a plan on Tuesday to take equity stakes in potentially thousands of banks totaling about $250 billion.

As part of the plan, the government would insure new preferred debt issued by banks and backstop all non-interest paying deposits, the paper said on its Website.

The plan marks a quick about-face for Washington policy-makers, who until recent days had been focusing on building an apparatus to soak up bad assets from banks.

The new push could provide faster relief to a paralyzed banking system and would put the United States more in line with Europe, where governments on Monday pledged billions of dollars to recapitalize banks or guarantee lending.

The blue chip Dow Jones industrial average soared 936 points in its biggest one-day gain ever in anticipation of aggressive new steps by U.S. policy-makers and the measures announced on the other side of the Atlantic.

"There's still a cloud ... over banks, but hopefully this will be the first rays of sunshine," Wayne Abernathy, a policy expert at the American Bankers Association, said of the U.S. Treasury's latest efforts.

The heads of Bank of America Corp , Goldman Sachs , Citigroup , JPMorgan Chase & Co , Morgan Stanley and New York Mellon Corp were among the executives scheduled to attend the 3 p.m.meeting, which lasted about two hours.

U.S. Federal Reserve Chairman Ben Bernanke and New York Federal Reserve Bank President Timothy Geithner also took part.

The stepped-up effort eased investor angst that the worst financial crisis since the 1930s was going to push the economy through a deep and protracted recession. Last week, world stocks hit five-year lows as sentiment soured, with the Dow recording its worst weekly loss on record.

DRAWING ON TAXPAYER FUNDS

Early this month, the U.S. Congress gave the Treasury power to buy as much as $700 billion in bad debts to help banks scrub their balance sheets and return to normal lending.

Paulson had previously opposed the idea of Washington buying a stake in banks, which is also permitted under the new law, but officials said they are now retooling the aid package to provide a direct capital injection.

"It's hard to avoid the sense that Mr. Paulson's initial response was distorted by ideology. Remember, he works for an administration whose philosophy of government can be summed up as 'private good, public bad,'" economist Paul Krugman, who won the Nobel price for economics on Monday, wrote in the New York Times.

Key Democratic lawmakers backed the new focus as a needed move to quell the crisis.

This "was not the original proposal but clearly there seems to be a consensus that is essentially what is necessary," said House of Representatives Majority Leader Steny Hoyer.

"The economists advise us (that this is) the most beneficial action that can be taken in the short term to stabilize the system," the Maryland Democrat said.

The head of the Treasury's $700 billion financial rescue program, Neel Kashkari, said the program would be designed to encourage healthy banks to participate.

"The equity purchase program will be voluntary and designed with attractive terms to encourage participation from healthy institutions. It will also encourage firms to raise new private capital to complement public capital," he told a banking group.

Temporary loan guarantees to ease bank borrowing were among the steps being considered, the Journal said.

(Additional reporting by Karey Wutkowski and Patrick Rucker)