Get your fresh Treasury-FDIC plan here

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So now the plan is out. Treasury will spend $250 billion of the $700 billion Congress gave it a couple weeks ago recapitalizing the nation’s banks and thrifts, starting with nine of the biggest. That is, it will buy senior preferred shares that will pay a divided of 5% a share for the next five years and 9% a share after that, and also get warrants to buy common stock worth 15% of the value of the preferred shares. Treasury won’t get any voting shares, but it will have veto power over any dividend increases or share buybacks.

Meanwhile, the FDIC says it will insure all “non-interest bearing deposit transaction accounts, regardless of dollar amount.” This applies mainly to business payroll and transaction accounts; the idea is to keep business customers from fleeing banks.

And in what marks perhaps the biggest leap into the unknown, the FDIC declares that:

Under the plan, certain newly issued senior unsecured debt issued on or before June 30, 2009, would be fully protected in the event the issuing institution subsequently fails, or its holding company files for bankruptcy. This includes promissory notes, commercial paper, inter-bank funding, and any unsecured portion of secured debt. Coverage would be limited to June 30, 2012, even if the maturity exceeds that date.

This is an acknowledgment of the reality, described here in depth a week ago, that banks in current-account-deficit countries like the U.S. are extremely dependent on senior unsecured lending. They’ve extended a lot more money in loans than they’ve taken in as deposits, and they bridge the gap with wholesale lending borrowing. Over time it would be a very good idea for banks to shrink this loan/deposit gap, but for the moment those wholesale lenders need to keep lending or the entire banking system collapses.

I feel like I’ve written about all this so much already that I’m becoming a broken record, so let me outsource my conclusion to Jeff Matthews:

[I]f you were asked to bail out your errant neighbor who had misspent his fortune building a McMansion and now couldn’t pay his mortgage, would you really want to take over your errant neighbor’s mortgage, and become his creditor?

Of course not.

You’d rather get ownership in the house, not only to make sure the guy keeps up the place, but to get the upside when he finally sells it.

Like that errant neighbor, Wall Street did, after all, screw it up, only on a super-spectacular scale beyond all imagination.

And Wall Street did so after decades of lobbying government to deregulate the very industry Wall Street subsequently destroyed.

So now that all those Wall Street hotshots are running to the government as the buyer of last resort, it seems only fair that those hotshots give up the most valuable piece of the capital structure: ownership.

Is it any wonder that Hank Paulson—the former head of Goldman Sachs, and one of the hottest of those hotshots—didn’t want to do that in the first place?

Update: Megan McArdle adds a wonkily interesting thought:

I’ve been told by an experimental economist that in some market models, more (true) information actually makes the market outcomes less efficient. This seems to be the mental model that Hank Paulson is working on: he’s essentially trying to enforce the pooling equilibrium that big financial players have been seeking for over a year. That is, he wants to recapitalize all the big banks, because recapitalizing only the weak ones would send a message about their balance sheets that might trigger the run he is trying to prevent.