Emergency planning.(THE ECONOMY)(Essay)

THE Paulson plan went from unpalatable to worse. The Treasury Department will now inject equity directly into major banks in exchange for preferred shares, making the institutions an offer they literally cannot refuse. Of the $700 billion in the bailout bill, $250 billion will be devoted to recapitalization of the banks, and Treasury secretary Hank Paulson has made it clear that he wants the banks to loan it back out quickly to businesses and other customers.

Originally, Paulson had proposed a slightly less intrusive scheme whereby Treasury would buy so-called toxic debt from financial institutions, then hold it until the crisis passed and resell it to private players. This procedure may still be an element of the plan, but it was too complicated (how to price the debt?) and would take too long (weeks to get the program up and running) to address a credit crisis that was spinning out of control by the hour. Prime Minister Gordon Brown proposed a direct equity injection in Britain, and with the rest of Europe following suit Paulson also got on board this approach as a simpler and faster option. The initial market reaction was positive, with credit markets showing slight signs of loosening.

Unfortunately, in a financial panic, there must be a lender of last resort, and in today's world only government is big enough to perform that function, one way or another. The old, tried and true prescription in a panic, going back to Alexander Hamilton and Walter Bagehot, is pumping liquidity into the system until the fit of madness passes. Paulson, Federal Reserve chairman Ben Bernanke, and FDIC chairman Sheila Bair--joined by central banks and finance ministers around the world--have been attempting this cure in every manner possible, with more deposit guarantees, with direct lending to small businesses, with guarantees of new debt issued by banks. It all ...