WASHINGTON-With last week's actions, the government has extended itself so far into every corner of financial services-investing directly in banks, buying unlimited amounts of commercial paper; and guaranteeing bank debt, interbank funding, and all noninterest-bearing deposits-that many observers said any eventual unwinding of the interventions would be so complex that some parts may never go away.
The degree to which the government's intervention will affect credit unions remains unknown. Even regulators acknowledged that some elements-such as the Federal Deposit Insurance Corp.'s decision to back bank debt-could be particularly difficult to reverse.
"Once you've done it, it's hard to roll back," Comptroller of the Currency John Dugan said. "If things calm down and there is more confidence, the question is: Will the government fail to step back from the guarantees, or will that act in and of itself create the kind of risk that requires the government to be there in the first place?"
Former regulators, academics and industry representatives said although many top officials claim the expanded programs will be targeted and temporary, government intervention in the markets is unlikely to go away anytime soon.
"They don't have a very good exit strategy," said Richard Herring, a professor of international banking at the Wharton School. "They've gone in massively, but it's not at all clear how you back away, and that has been the history in all the countries that have tried this out. They make all these guarantees, and there is sort of never quite the right time to remove them."
Individually, many pieces of the plan have deadlines and withdrawal strategies. But observers said the sweeping nature of the intervention left those deadlines in doubt and expressed concerns about whether the strategies would work. Ultimately, the decision to offer $250 billion of equity stakes to banks and thrifts may be the least complicated decision to undo-though several analysts still raised concerns.
Under the plan, the Treasury Department would take positions in senior preferred stock of selected banks for three years. Then the banks may redeem the Treasury's shares at the whole price, plus any accrued and unpaid dividends. After five years, the Treasury's dividends are to rise to 9%, from 5%, making it more costly for the shares to remain outstanding and encouraging their redemption.
Dugan, for one, said this would work to let the government back away from directly holding stock in institutions. "On the capital injections, you have a trigger at three years. It becomes less attractive to own the stock as the coupon rate jumps up, and at that moment you can redeem the stock without having to commit to replace it with Tier 1 equity," he said. "That's kind of a natural place for the stock to be redeemed, and people may have an incentive to do so at that time. The stock was designed with those thoughts in mind."
But others were not so sure. Chris Low, the chief economist at First Horizon National Corp.'s FTN Capital Financial, said that unless private equity is ready to return to the market within three years, the government will not be able to withdraw. "It depends on how quickly the market recovers," he added. "The assumption is that private capital will follow government capital into the banking system now that investors have been reassured that it's safe, but there's no indication that will be the case."
L. Richard Fischer, a partner in Morrison & Foerster, agreed such a scenario is unlikely and questioned how many years it would take the government to pull back. "The question is whether it's going to be single digits or more, because it will depend on how long it will take for the market to settle," he said. "You can't really get out of it as easily because we've done all of this in a period of about two months, and it will take far longer to get out."
But analysts see it as even harder for the government to pull back on a guarantee of bank debt. Under the plan, the FDIC will back senior unsecured debt issued between Oct. 14, 2008 and June 30, 2009, for three years. After 30 days, banks must pay a steep premium to participate-75 cents for every $100 of debt-but the debt would be backed by the government. FDIC officials estimated that roughly $1.4 trillion of debt could be backed by the agency. That would include interbank funding, promissory notes, commercial paper, and any unsecured portion of secured debt, the FDIC said.
The agency also said it would backstop all noninterest-bearing bank accounts-a move that effectively covers most corporate and municipal accounts. Following a 30-day period of free coverage, banks that participate will face an additional 10-basis-point premium for the backstop. This coverage would expire at the end of next year.
But many, including Dugan, wondered whether that would be possible. Once investors become used to a government guarantee of bank debt it may be hard to retrench. "There's a way to do an exit strategy there ... [but] that may prove to be difficult when we get to that place," Dugan said.
Some former regulators and other analysts agreed, but in a conference call with reporters, FDIC Chairman Sheila Bair disagreed, saying the agency could devise economic incentives to wean banks off the added coverage and debt guarantees, she said.
