With a $250 billion investment in the nation's banks, Washington has crossed a Rubicon, abandoning any hope for a private-market solution to the credit crisis. This is a new era of state capitalism.

Yet capitalists are hailing the move, which comes on the heels of $2.5 trillion in bank cash infusions by European governments, seeing it as the only hope to stop a collapse of the financial system.

"We're looking today at an absolute sea change in the global financial system in terms of liquidity," Stephen Schwarzman of Blackstone Group told a conference in Dubai today, according to Bloomberg News. "This could be the time that breaks the back of the credit crisis."

Stocks in the United States, however, retreated a day after a powerful rally. The market opened sharply higher but then swung wildly. The Dow Jones industrial average closed down 76.62 points, after trading in a range of 700 points. On Monday, it surged 936 points, its biggest point gain ever. The trading underscores that there are no quick fixes to the crisis. And even when the financial panic is quelled, the economy will continue to struggle in the throes of a recession. Credit markets eased today, with the dollar Libor rate slipping a bit.

Treasury plans to inject $250 billion into the nations' banks. About half will be invested into nine: Citigroup, Bank of America, Wells Fargo, J.P. Morgan Chase, State Street, and Bank of New York Mellon, as well as Merrill Lynch (which is being acquired by Bank of America), Morgan Stanley, and Goldman Sachs, which are now bank holding companies.

In announcing the plan this morning, Treasury Secretary Hank Paulson said that the banks that agree to sell preferred shares must accept restrictions on executive compensation, including a clawback provision on bonuses and a ban on golden parachutes as long as the government holds a stake.

He said that he expected participating banks to help struggling homeowners and to continue efforts to raise additional private capital. 

"The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it ,” he said.

At the news conference with Paulson and Ben Bernanke, the Federal Reserve chairman,  the chairwoman of the Federal Deposit Insurance Corp., Sheila Bair, said that the "bulk of the U.S. banking system is healthy."

But to deal with the credit crisis, the F.D.I.C. will temporarily guarantee the senior debt of banks, she said. And it will provide unlimited insurance coverage for noninterest-paying accounts, like payroll accounts, typically used by small businesses.

The Federal Reserve, meanwhile, is finalizing a program to back commercial paper, the short-term debt used by many large companies to finance their day-to-day operations.

Earlier, President Bush outlined the steps being taken. "This is an essential short-term measure to ensure the viability of the American banking system," the president said. He stressed that the crisis was a temporary one and a global one, hailing the steps by Britain and other European governments to shore up their banks. They are "wise and timely actions," he said.

The nine U.S. big banks were told about their cash infusions at a sit-down with Paulson on Monday afternoon. The banks were reportedly not given a choice and signed agreements.

The rest of the $250 billion will go into smaller banks and savings and loans. The money is coming from the $700 billion Troubled Assets Relief Program.

The government will make these investments by taking perpetual preferred shares that pay a dividend of 5 percent. The payout rises to 9 percent after five years These shares will not dilute common shareholders, at least not at first. But the government will receive warrants for 15 percent of the face value of the preferred shares. The terms of the preferred shares will be the same for small and mid-sized institutions as it is for the big banks.

Many economists have been calling for a recapitalization of the banks, providing new capital and bolstering their balance so that they can return to lending. 

"The government's initial $250 billion dollar investment in the countries largest banks will be significant in that it will dramatically strengthen the balance sheets of the companies that hold the vast majority of the banking systems assets and deposits," notes the Prudent Speculations blog.

But everyone may not be on board. Paulson is expected to ask Congress for another $100 billion, the Washington Post reports.

"When I was talking to members of Congress back then, they believed they were voting to buy up troubled assets, not to make capital infusions in banks," Alan Blinder, a Princeton economist and a former Fed vice chairman told the paper. "If I were a member of Congress, I would be wondering about bait and switch because that was not really discussed."

Yves Smith on Naked Capitalism wonders how arms at the banks were twisted: "Even with the Treasury's sweeping new powers under the $700 billion rescue package, one wonders how it compelled banks to cooperate. The process by which this was done is alarming."