One option presented by Euromoney last week as an alternative to Paulson's US bail out plan included using public money to recapitalise the banks directly by taking equity stakes. The Treasury secretary now seems to be warming to this idea.....

If the federal government believes that it must recapitalize the banking system, then it should do so directly by investing equity in the banks. Buying troubled assets at above market prices achieves much the same thing – it hands capital to the banks and transfers risks of loss to the public purse. Surely there is no need to make things more complicated than they need be by creating a false market in hard-to-value securities.

Having urged Congress to pass Tarp in September with warnings of financial meltdown if it did not, Paulson was forced to admit on October 8 just how unprepared the US Treasury is to implement it. He says: “We expect it will be several weeks before our first purchase.” In the meantime, he points out that the Emergency Economic Stabilization Act empowers the Treasury to “inject capital” as well as to buy bad assets from banks and provide guarantees.

It is perhaps understandable that the government of the country previously regarded as the champion of free markets should be reluctant to build a portfolio of majority and minority equity stakes in banks. However, doing so might encourage more private-sector investors to follow as co-investors.

For the complete story on Euromoney.com, click here.