Treasury may capitalize banks by end of October: source

WASHINGTON (Reuters) - The U.S. Treasury Department plans to start directly injecting capital in U.S. banks as soon as the end of October in exchange for passive investment stakes, according to a financial policy source familiar with Treasury Secretary Henry Paulson's thinking.

Using authority granted to it by last week's $700 billion market rescue legislation, Treasury would get common or preferred shares in the banks it capitalizes, the source told Reuters on Thursday. The government does not intend to seek seats on companies' board of directors in the voluntary capitalization program.

White House spokeswoman Dana Perino said later on Thursday that Paulson is "actively considering" capital injections into troubled U.S. banks.

"Secretary Paulson is looking at all the different tools to figure out which ones should be used at what time and how robustly and how much money to put into each," she said.

A Treasury spokesperson declined to comment in detail but said: "Treasury has broad, flexible authorities under the financial rescue legislation to buy assets, provide guarantees and inject capital and intends to consider all of them."

If the U.S. Treasury does inject capital into banks, it would be following the playbook of the British government, which on Wednesday pledged up to $87 billion to shore up banks' capital in exchange for preference shares.

The source familiar with Paulson's thinking said Treasury was working "extremely fast" to put together a capital injection plan.

The effect of injecting capital would be to boost banks' capacity to lend, thus complementing the bailout bill's objective of removing soured mortgage-backed assets weighing on banks' balance sheets.

Some critics of the proposals for buying soured mortgage-related products have said the process would take so long that it would reduce its efficiency, whereas a capital injection through share purchases would immediately put more cash for lending into the banking system.

The question may be whether banks are willing to accept the government as a stakeholder in return for the new capital.

The source said the injections would likely be made public, possibly inducing some reluctance among bankers to use it for fear that they would be identified as vulnerable institutions.

In addition, it was unclear whether a bank that wanted to participate would have to agree to conditions like limits on executive pay and an end to "golden parachutes," or rich pay packets for departing executives.

While public fury remains high at what is perceived as excessive pay for financial firms, corporations are generally reluctant to cede control over compensation levels, perhaps especially so to the government.

Paulson made clear on Wednesday that he interprets the authority granted by the financial rescue package as sweeping and that he intends to make full use of it. He said most attention has focused on Treasury plans to buy distressed securities from banks but made clear that wasn't the extent of his new authorities.

"We will use all of the tools we've been given to maximum effectiveness, including strengthening the capitalization of financial institutions of every size," he said.

(Additional reporting by Andy Sullivan and Glenn Somerville; Editing by Leslie Adler)