Bailout Ultimatum: Uncle Sam Wants Chase, BofA, Goldman As Partners

Under the U.S. government’s economic rescue plan, the nation’s biggest banks get richer. And the smaller banks? Well, they get to wait in line.

The U.S. Treasury will quickly invest about $125 billion to purchase ownership stakes in nine of the nation’s largest banks, including JP Morgan Chase, Bank of America, Citigroup, and Wells Fargo. Also in that group: Goldman Sachs and Morgan Stanley, which recently coverted from investment banks to bank holding companies. The government will acquire preferred equity stakes in these institutions and then eventually deploy an additional $125 billion to back many regional and smaller bank holding companies.

Not all of the major banks wanted the cash-for-equity deal, but government regulators insisted they all participate in the program. Excluding any large bank could undermine the bailout plan’s effectiveness and hurt its goal of restoring across-the-board confidence in the banking sector and breaking through the credit crunch, regulators argue.

One reluctant partner is probably JP Morgan Chase. Chase is making money, has a capital ratio of 9.1 percent (above the regulatory requirement), and boasts one of the industry’s healthier loan portfolios, having sidestepped the bulk of the subprime lending disaster. Chase CEO Jamie Dimon knows the Fed’s money comes with strings attached. Not only does the government have an ownership stake, the recently approved $700 billion economic recovery law, which empowers the U.S. government to buy bank equity positions, also pushes for greater regulatory oversight and caps on CEO pay. Right now, Treasury Secretary Hank Paulson isn’t pushing for any major compensation limits but that could change if Congress gets involved in the implementation of the rescue plan.

Despite those restrictions, most of the large banks are welcoming the government with open arms. That’s especially true for Goldman and Morgan, which are scrambling for private investor capital and are reeling from the weight of toxic mortgage-backed securities. The government had little choice but to backstop the banks. In addition to buying equity, it is extending federal protection of all new debt and extending insurance protection on all money in non-interest bearing accounts, usually payment programs used by small businesses.

In recent weeks, bank-to-bank lending has slowed to a trickle because banks couldn’t trust each other to pay back. As those transactions slowed, overall corporate and consumer borrowing seized up. While today’s plan outlines what the cash infusion means to the country’s largest banks, it’s unclear just how it will affect the nearly 8,000 regional and community bank scattered throughout the country. It’s expected that those banks will have a more leeway when it comes to taking part in the program. Some may opt to participate, while others may not.