Oct. 15 (Bloomberg) -- Once U.K. Prime Minister Gordon Brown decided to recapitalize his nation's banks, other European countries and the U.S. had no choice but to fall in line. That doesn't mean the federal government should try to run the banks that join the $250 billion program.

Participation was hardly optional for the nine large institutions whose chief executives were summoned to a Treasury Department conference room with Secretary Henry Paulson on Oct. 13. In short, the nine -- Citigroup Inc., Goldman Sachs Group Inc., Bank of America, Merrill Lynch & Co., Wells Fargo & Co., JPMorgan Chase & Co., Morgan Stanley, State Street Corp. and Bank of New York Mellon Corp.-- were told that accepting an initial $125 billion in government capital was the patriotic thing to do.

``These are healthy institutions, and they have taken this step for the good of the U.S. economy,'' Paulson said. And now they are supposed to do their duty by using their bigger capital base to expand lending.

That's just what the economy needs, though there's a danger.

In an Oct. 14 editorial, the New York Times said, ``The Treasury should also insist on stepped-up government supervision to ensure that sound lending resumes -- and that reckless lending does not. Government regulators need to frequently review the rescued firms' operations, daily if necessary.''

Is the Treasury supposed to draft a set of rules defining ``reckless lending''? Good luck.

Even in the face of an economic crisis, the last thing anyone should want is a focus on avoiding all risk in making loans. Sound lending always entails some losses, as almost any economist would argue.

Lending Decisions

No government regulator ought to make lending decisions for banks, except in the broadest terms. At the extreme, one could envisage a constituent calling a member of Congress complaining that a bank with government capital was about to cut off his credit line. Or perhaps another constituent complains he can't get a loan for his business and scores of jobs are at stake.

Maybe that's farfetched, or maybe not.

That's not to say there shouldn't be more government supervision. Too little regulation and supervision contributed to the mess the financial system is in, and both need to be tightened regardless of whether taxpayer money is at risk. The broad $700 billion rescue plan, which includes the $250 billion in new capital for banks, includes a requirement that, by the end of April, the Treasury secretary report on the effectiveness of the financial regulatory system and recommendations for changing it.

Getting a Break

Meanwhile, homeowners behind on their mortgage payments are supposed to get a break from banks that get a capital infusion.

``We expect all participating banks to continue and to strengthen their efforts to help struggling homeowners who can afford their homes avoid foreclosure,'' Paulson said in announcing the program.

Another $125 billion of capital is available to other U.S.- controlled institutions until Nov. 14, with the funds to be invested by the end of the year.

The Treasury also is moving ahead with Paulson's original plan to buy troubled mortgage-related assets from banks, as Assistant Secretary for Financial Stability Neel Kashkari explained in an Oct. 13 speech. Many economists have argued the secretary should have focused from the beginning on injecting capital instead of buying assets.

As it turned out, there simply wasn't enough time to get the asset-purchase plan in place once the stock market collapsed and interbank lending and commercial paper issuance all but halted.

Big Enough

Now questions are being raised about whether the plan is big enough.

On a comparable basis, the U.K. is putting twice as much capital into its banks as the U.S. Whether $250 billion will prove to be adequate may depend on the size of banks' losses on bad assets in coming months, particularly now the that U.S. economy looks like it may be headed for a serious recession.

Economist Paul Ashworth of Capital Economics in London told his clients yesterday that he expects those losses to reach an additional $250 billion over the next two years. U.S. financial institutions have recorded more than $380 billion in losses since the crisis began last year.

``The upshot is that all the Treasury will succeed in doing is offsetting future losses and preventing capital adequacy ratios from falling,'' Ashworth said. ``As it stands, we still expect banks to shrink their loan portfolios by roughly 10 percent over the next couple of years, putting more downward pressure on economic activity.''

Doing More

Of course, the government has taken other important steps, and will take more if needed. The Federal Deposit Insurance Corp. is going to guarantee senior debt of all FDIC-insured institutions, and the money in the accounts of most businesses. The Federal Reserve has made unlimited amounts of money available to many foreign central banks in exchange for their local currency and, as of Oct. 27, will begin to buy three-month commercial paper from high-quality issuers.

Democratic congressional leaders are pushing another fiscal stimulus program. Senator John McCain, the Republican presidential candidate, and his Democratic opponent, Senator Barack Obama, have announced their own proposals to spur the economy.

It's all going to be very expensive. Unfortunately, not spending the money would be even more costly to the economy.

(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net

Last Updated: October 15, 2008 00:01 EDT