Massive bailout plan won't work overnight

Injecting money directly into banks through stock purchases will produce a more immediate impact. Each new dollar dropped on a bank’s books gives it the financial reserves to lend out $10. By forcing money into the banking system, the government is hoping to break the lending logjam that has cut off borrowing to many businesses and consumers and it threatening to tip the economy into a deep recession.

The move is also designed to save otherwise healthy banks. Bair said the “overwhelming majority” of banks are still in good shape.

“What we’re trying to prevent now really is liquidity failures — failures of banks that are otherwise quite healthy, have plenty of capital, plenty of loan loss reserves to deal with the challenges that lies ahead, but because of uncertainty their liquidity is draining and we don't want to close those institutions,” she said. “That’s what these guarantees are about — to prevent unnecessary failures.”

Bernanke also underscored the need for massive intervention before the panic inflicts more damage on the financial system and the economy.

“History teaches us that government engagement in times of severe financial crisis often arrives very late, usually at a point at which most financial institutions are insolvent or nearly so,” Bernanke said. “Waiting too long to act has usually led to much greater direct costs of the intervention itself and, more importantly, magnified the painful effects of financial turmoil on households and businesses. That is not the situation we face today.”

While officials stressed the speed with which they had acted, the U.S. response followed similar moves by European authorities over the past week. On Sunday, the Bank of England moved to partially nationalize British banks. Several European countries already had pledged to back all bank deposits.

Those moves may have had a hand in prompting the U.S. action. Some bankers feared that if European banks were perceived as safer, U.S. depositors might shift assets to those banks.

A major component of the plan is its international scope. Though the crisis has galvanized U.S. and European countries in a coordinated effort, financial markets will be watching closely to see how well that cooperation holds up.

Opposition to direct government intervention in the United States has come from both sides of the aisle. In the debate over the $700 billion bailout plan, House Republicans attacked it as socialist interference in free markets. Democrats complained that it was bailing out rich bankers who made bad bets.

In announcing the plan, President Bush stressed that the plan doesn’t signal a long-term role for the government.

“The government’s role will be limited and temporary,” Bush said. “These measures are not intended to take over the free market but to preserve it.”

It’s far from clear what the government’s exit strategy will be. The history of financial panics shows that they are rarely resolved in a single moment by a single measure. The loss of confidence that underlies the current panic took years to develop; it will be months at least before some measure of confidence is restored.

But the hope is that the massive global response to the panic will prevent the kind of economic damage that has followed shocks when government was slow to act, like the prolonged downturn in the Japanese economy after that country’s stock and real estate markets collapsed in 1989.

“You’re getting a reaction way before you got the reaction in Japan,” said Mohamed El-Erian, co-CEO of bond fund Pimco. “Therefore, there is a hope that you can save the country from 10 years of stagnant growth.”

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