U.S. to take $250 billion bank stakes, markets slip

By Daniel Trotta

NEW YORK (Reuters) - The United States ushered in a new era in banking on Tuesday with plans to take equity stakes totaling up to $250 billion in financial institutions, an incursion into the private sector that U.S. officials called a regrettable last resort.

Markets initially rallied on the rescue plan, continuing the previous day's rebound, but recession fears soon took over and Wall Street stocks closed lower.

U.S. Treasury Secretary Henry Paulson said government ownership of big stakes in banks was "objectionable" but necessary to head off the financial crisis.

"At a time when events naturally make even the most daring investors more risk-averse, the needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it," Paulson said.

Governments around the world have pledged roughly $3.2 trillion in a variety of schemes that guarantee bank deposits, interbank lending and the purchase of new securities to shore up bank capital.

The U.S. Treasury will buy nonvoting preferred shares in major financial institutions, with stakes in each limited to $25 billion. Bank executives must accept standards of corporate governance and limits on their pay.

Paulson said nine banks that he described as "healthy institutions" had agreed to accept government stakes for the good of the U.S. economy -- a government intervention unthinkable before the credit crisis, the worst since the 1930s Great Depression.

"These measures are not intended to take over the free market but to preserve it," U.S. President George W. Bush said.

Bush said the Federal Deposit Insurance Corporation would guarantee new bank debt and that the Federal Reserve would become a buyer of last resort of commercial paper -- the short-term loans that companies use to fund day-to-day operations.

RECESSION FEAR

Investors liked the bold government action but recession worries killed a rally in U.S. stocks. The third-quarter earnings season has begun and the U.S. Commerce Department is due to release third-quarter GDP data on October 30.

"The world is not going back to where it was before September," said Andrew Busch, a strategist with BMO Capital Markets in Chicago. "The (credit) freeze has meant that the outlook for the economy has soured and we're still not sure by how much.

The Dow Jones industrial average closed 0.8 percent lower and the S&P 500 was down 0.5 percent. Both indexes on Monday had registered their biggest one-day point gain in the wake of last week's panic sell-off.

U.S. Treasuries fell on worries that the U.S. government would issue bonds to finance the bank rescue package.

Oil and the U.S. dollar fell.