Plan B

A massive financial bailout package was passed by Congress on Friday, but frozen credit markets remain stalled and stock investors still have a bad case of the jitters.

Banks are afraid to issue new loans to businesses and individuals alike - loans that are the lifeblood of the economy. Individuals use them to buy cars, houses and dishwashers, and businesses use them to cover day-to-day expenses, including a little thing called payroll. With no loans to cover short-term expenses, businesses may have to figure out a way to save somewhere (read: job cuts), and that’s a situation nobody wants.

When it was first proposed, some considered the $700 billion government bailout package a drastic step - it is the largest government intervention into the economy since the Great Depression - but the passage into law has not kick-started credit markets yet.

That’s why the government might be might be considering more radical steps to jumpstart confidence in the economy. In my last blog, I told you some of the tools the Fed and the Treasury Department have used so far. On Wednesday, Treasury Secretary Henry Paulson said the government is considering “all options” to shore up the U.S. economy, and reports of possible options under consideration have proliferated. Let’s take a look at what Plan B is starting to look like:

1. The government could take direct ownership stakes in banks. Reports out say the government is considering exercising a new power granted it in the bailout bill to directly inject capital into banks in exchange for ownership stakes. The thinking is that this would instill enough confidence - and cash - in these banks to spur more lending. But, it’s a move that makes market purists cringe, who loathe growing government interference in the economy.

2. The government could continue to lend gobs of cash to troubled financial institutions. On Wednesday, the Fed said it will lend $40 billion more to insurance giant AIG. That’s on top of the $85 billion the government gave AIG last month. The government’s lending policies are very flexible given the bailout, and lending to troubled financial giants will likely continue. It’s considered a less extreme measure than actually buying ownership shares of a company.

3. The Fed might cut interest rates even further. On Wednesday, the Fed, in conjunction with 5 other central banks around the world, cut its benchmark rate by half a percentage point. It was the first time in history that the central banks have acted together to cut interest rates. Since the credit market remained stalled even after the announcement, a further interest rate cut could be possible.

The point of all this is, of course, that the government is not out of options. But this is really a trial-and-error method. There is no precedent for this sort of global downturn, and the even the financial wizards at the Fed and Treasury Department can’t know how investors and banks will react to their decisions. Even drastic measures may have little effect. In a lot of ways, it’s just a waiting game.