U.S. eyes bank equity stakes as world looks to G7

NEW YORK/WASHINGTON (Reuters) - The United States moved closer to taking equity stakes in banks on Thursday ahead of a G7 meeting of economic powers trying to stave off world financial ruin.

The Treasury Department plans to start directly injecting capital in U.S. banks as soon as the end of October, according to a financial policy source familiar with Treasury Secretary Henry Paulson’s thinking.

It would be the latest step to combat the widening financial crisis in which major economies have rescued banks, injected massive amounts of liquidity into markets, agreed to take toxic debt off the books of financial institutions and slashed interest rates.

South Korea and Taiwan cut interest rates on Thursday following the coordinated cuts on Wednesday by major central banks including the U.S. Federal Reserve. Japan was considering other measures in the face of new recessionary signals.

Even so, U.S. stocks were largely trading down on Thursday and investors were still calling on politicians from the G7 and European Union to show they can cooperate more effectively.

The Dow and the S&P 500 were down more than 1 percent, diminishing hopes Wall Street would end a six-day losing streak in which share prices fell almost 15 percent.

European stocks lost more than 2 percent after trading higher much of the day.

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Finance ministers and central bankers from the Group of Seven major industrial nations will meet in Washington on Friday, with International Monetary Fund Managing Director Dominique Strauss-Kahn calling for more coordination.

“The coordination that needs to take place is probably greater than the G7 itself. That’s why it’s important that this meeting is also the G20,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

“Given the fragility of market sentiment right now, a disappointment could further exacerbate the problem.”

That has raised the question of what options remain for policy makers to combat the market meltdown, which has destroyed lenders from Wall Street to Iceland to Germany and left people worried about the security of their savings and jobs.

“If you scour the history books, (the steps taken or being considered) are the only policy options of last resort,” said David Mackie, head of Western European economic research at JPMorgan.

“I can’t think of what else people might come up with here. Various countries have done bits and pieces. Nobody has done all of them,” he said.

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“It’s not entirely obvious that these measures are turning the tide,” Mackie said. “At the end of the day, if you socialize enough of the financial system, it has to work.”

Policy makers want to free up credit but have yet to overcome the lack of confidence that has virtually halted lending between banks. One option is for other countries to follow Britain’s pledge to guarantee short-term interbank lending.

The cost of borrowing overnight cash fell on Thursday but longer-term funding costs stayed high.

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The Treasury’s bank recapitalization plan was an option included in the $700 billion rescue plan approved last week in which the government will buy bad loans from financial institutions in the hope that it will jump-start lending.

Treasury plans to inject capital in exchange for common and preferred shares and does not intend to seek board seats in the voluntary program, the source familiar with Paulson’s thinking told Reuters.

The United States would be following the lead of Britain, which said on Wednesday it was prepared to inject 50 billion pounds ($87 billion) of taxpayer money into its banks and guarantee interbank lending.

EU states remained divided over the need to set up a financial supervisor with responsibility across Europe, and Paulson said a one-size-fits-all approach may not be right for members of the G7.

U.S. markets faced additional uncertainty after a ban on short-selling of financial stocks expired at midnight on Wednesday.

Short-sellers bet on falling stock prices and have been blamed for driving share prices lower, though advocates of the tactic say they were first to point out underlying weakness in financial firms.

Additional reporting by Reuters bureaus around the world; Editing by Brian Moss and Steve Orlofsky