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Paulson Says Stock-Buying Aimed at `Regulated\' Firms

Date: Thursday, October 16, 2008
Author: Peter Cook and Rebecca Christie, Bloomberg

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U.S. Treasury Secretary Henry Paulson said his plan to inject capital into financial companies is focused on banks and thrifts, indicating unregulated firms such as hedge funds won't initially get government aid.

``We're focused on financial institutions, regulated financial institutions,'' Paulson said in an interview with Bloomberg Television, when asked whether hedge funds might also be eligible. ``The program right now is for banks and thrifts.''

The worst credit crisis in more than seven decades is cutting a wider swath across the financial system than Paulson expected. Citadel Investment Group Inc.'s biggest hedge fund fell as much as 30 percent this year because of losses on convertible bonds, stocks and corporate debt, two people familiar with the Chicago-based firm said.

Paulson pushed Congress to pass a financial rescue package that gives him broad authority to pump money into cash-strapped banks. Earlier this week, he said the first $250 billion of the overall $700 billion rescue would go into the balance sheets of financial companies in exchange for non-voting, preferred equity.

Financial companies need to regain confidence so they can extend credit to businesses and households, the Treasury chief said. Banking strains have hurt broader economic growth, pushing the U.S. toward a recession.

``There's been a shock in the credit markets, and that's exacted a toll on the real economy,'' Paulson said.

Factory Output

Earlier today, a Federal Reserve report showed industrial production in the U.S. fell in September by the most in almost 34 years as hurricanes and an aircraft strike combined with the credit crunch to weaken manufacturing.

A separate report from the Labor Department showed the cost of living in the U.S. was unchanged in September, restrained by plunging fuel costs and decreases in automobile prices and airline fares.

U.S. stocks have fallen for three straight days since Paulson's Oct. 14 announcement of the equity purchases. The Standard & Poor's 500 Index yesterday dropped 9 percent and fell much as 3 percent today.

``You don't want to react too much to the equity market any single day,'' Paulson said in the interview. ``But if you look at credit spreads, if you look at some of the indicators that I look at every day, there's no doubt in my mind we've done the right things.''

`Perverse Incentives'

Paulson acknowledged the need to make sure banks and their executives have the right incentives to restart lending. He said Congress was right to be concerned about pay for chief executive officers and other industry officials.

``It is important to me that when you look at financial institutions that we not have perverse incentives or people's interests in compensation encourage excessive risk-taking,'' Paulson said, while declining to comment on compensation at specific firms.

Senator Robert Casey, a Pennsylvania Democrat, wrote Paulson today saying the bank rescue efforts don't do enough to help households.

``It troubles me that the Treasury has committed $250 billion to an effort to provide help to banks, without modifying a single mortgage,'' Casey said in a statement.

U.S. homeowners are struggling as the value of their houses declines. The number of U.S. foreclosures rose 27 percent in August to 303,879 from a year earlier, according to RealtyTrac Foreclosure report.

Foreclosure Response

In the interview, Paulson said the Treasury is considering more steps to limit foreclosures.

``We were talking about additional things we can do with the banks,'' he said. ``We have made a big dent in the problem in terms of reducing the numbers, but they are still too high and we're dealing with a housing problem.''

Paulson's plans to help banks raise capital quickly may help address clogged credit channels, which would help unfreeze the overall economy, said Ross Levine, an economics professor at Brown University in Providence, Rhode Island.

Still, the plan seems risky because it may not set up the right incentives, leading banks to pursue short-term gains without returning to long-term health, he said. ``If you get it wrong the problem is going to multiply and they're going to be coming back for more money,'' Levine said.

To contact the reporters on this story: Peter Cook in Washington at pcook6@bloomberg.net; Rebecca Christie in Washington at Rchristie4@bloomberg.net.