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BRZEZINSKI: Welcome back to THE RACE. We want to let you know that the Treasury Secretary Hank Paulson is announcing the U.S. government will move ahead with its plan to buy stock in the financial institutions. I am rejoined now by David Gregory, who has been covering the developments for NBC NIGHTLY NEWS. And also with me, Dylan Ratigan, anchor on CNBC`s FAST MONEY and THE CALL. Within the next few minutes we`re going to hear from the treasury secretary live. Henry Paulson is going to hold a news conference to give details about how the $700 billion rescue package will be implemented. And David, of course, this along with a big weekend ahead with finance ministers at the White House.

GREGORY: Right and I think what is important is that you have an image that the White House is trying to create here. And that is of coordination, that the U.S. administration is working foreign governments, the biggest economies in the world actually working together on coordinating their actions. What they want to coordinate principally is measures to shore up failing banks. And I want to bring in Dylan Ratigan in on this and I know we have Paul Krugman as well standing by from "The New York Times." Dylan, what is striking about the move today, I`ve been talking to White House officials, there is a recognition. That this is not just today but in past days that is correct the initial approach is simply buying the debt with the $700 billion from the struggling institutions is not enough. Now they have to take the step of getting the equity state. Giving money directly to the banks for fear that they`ll go under otherwise. Amplify on the significance of that and what we`ll hear from Secretary Paulson.

RATIGAN: Again, understand what this has come to. The seizure in the U.S. banking system is such that we`ve trillions of dollars of both taxpayer money and other moneys having been thrown at the situation, the banking system, still, David, refuses to unlock. You have to ask yourself why that is. What is the risk that bankers see that they refuse to interact with one another. And the only potential answering answer to that is that the result of the bad housing debt, because of the housing finance system that was created as a matter of policy largely over the past ten years is so big, that until the banks have the benefit of the total comfort, not only of our Federal Reserve, but of all the major finance ministers in the world, that they will not allow themselves to reengage. It`s a reflection of how big the potential problem of housing finance that was created through the policy actions of the past 10 years is, David.

GREGORY: Paul Krugman, the White House officials here say, look. This is not nationalizing the banking system. The government won`t have any voting rights in these banks. We`re just making a loan, essentially. We`re buying equity so that they stay afloat. Is that how you see it? Why is Paulson taking this step now?

PAUL KRUGMAN, PRINCETON ECONOMIST: It is a bit more than taking the loan. You`re taking an ownership stake although not a voting stake. We`ll see whether more comes. But it is actually a major reversal. This kind of thing, essentially buying preferred shares, buying into the banks was what a lot of us thought should have been done from day one. It is the standard way you deal with this banking crisis. It does expose the taxpayers to a possible loss but it is a way of getting the banks able to meet their debts. So this is actually good news after basically wasting four weeks Paulson is now doing what a majority of the economists I talk to say he should do. But it is huge. It is an awesome step.

RATIGAN: Understand this, David. The problem is banks have this much money and they lent this much money. What we`re looking at here is a government stepping in to make this much money back into this much money, so that the burden of all those loans doesn`t basically make the banking system collapse.

KRUGMAN: Recapitalizing our banks.

RATIGAN: Exactly.

GREGORY: Pumping, priming the pump, essentially into the bank.

RATIGAN: In effect, they took too much risk and now we have to bail them out. I`m sorry, Paul.

KRUGMAN: It is not clear that -- other countries have done this. The Swedes put in a bunch of money and got most of it back, it didn`t cost them much in the end. Hopefully this will be the same here. There is not enough working capital for the banking system to operate so Paulson needs to pump it in. Realism, a little bit of facing reality is good to see finally at long last.

RATIGAN: Here, here.

GREGORY: This becomes, Dylan, the confidence question. Who has lacked confidence and why will this be the step that actually restores confidence when other things have not worked? I pointed out that President Bush has spoken five times in the last seven days to try to calm the markets.

RATIGAN: The largest investors in the world, David, and all of the major banks in the world, are the ones who lack confidence. In other words, the banks themselves are skeptical to lend money to one another for fear that they do not have enough money to back up a loan or pay back a loan, were it to come in. Which goes to what Paul was talking about. The reason we even have to make these investments that you speak of, David, is because the banks are so fear. That other banks are under so much housing debt that they will not be able to repay a loan. And as a result, the lending system at its highest levels, among the biggest investors and biggest banks, that`s where confidence has been lost. That`s what we were trying to restore confidence by the measure that we were talking about this evening.

GREGORY: Let me say to our viewers. We`re less than two minutes away from seeing and hearing from Secretary Paulson. He`s been meeting with the G-7 leaders all day long. You see a live picture there from the Treasury Department. The president will address this group tomorrow. Again, what is key here is that they`re taking coordinated action, announcing steps to shore up troubled banks around the world. This is a banking, a financial crisis that has spilled into the global economy. Paul Krugman, a political question here for these two candidates as they slug it out on the economy. As an economist yourself, what do you worry with in material of continuity in policy here, and direction? As we`re just 25 days away from an election. And then a transition period before a new administration takes place.

KRUGMAN: I would hope we can actually form, at least on the financial front, a government of national unity the day after the election. To have basically, presumably, tempting fate but presumably it`s going to be Obama, that Obama`s people will start in fact being in policy making role in concert with the Treasury Department, right from the day, the moment that the networks call the election. This is too dangerous.

RATIGAN: We`re at a precipice here. Think about the, it growth in the `80s in brief was a function of making efficient our capital structure. There were hugely high interest rates in the late `70s. They came down by the end of that decade. Tax policy was rewritten. Money moved around more easily. The `80s were a boom decade. The `90s we innovated the Internet, the advent of that technology delivered jobs, growth across the board. This decade driven by a housing boom that was supported by credit. That now is over. The question for the next president of the United States is how will you precipitate meaningful economic activity through innovation, whether it`s health care solutions or energy solutions, in the next decade.

GREGORY: All right. Gentlemen and Paul, thank you very much. Here now, Treasury Secretary Henry Paulson.

HENRY PAULSON, TREASURY SECRETARY: . of the G-7 finance ministers and central bank governors. We finalized an aggressive action plan to address the turmoil in the global financial markets and the stresses in the financial institutions.

This action plan provides a coherent framework that will direct our individual and collective policy steps to provide liquidity to markets, strengthen financial institutions, protect savers, and enforce investor protections.

The G-7 is compelled to robust international partnership and cooperation. Never has it been more important to find collective solutions to ensure stable and efficient financial markets and restore the health of the world economy.

Global financial market conditions are severely strained. In the United States, our economy has been facing a prolonged period of uncertainty and our financial markets are experiencing unprecedented and extraordinary challenges. A root cause of this situation is the housing correction, and a lack of confidence in mortgage assets, as well as a lack of confidence in many of the financial institutions that hold these assets.

We are squarely focused on the immediate need to stabilize our financial markets and recognize that investor confidence is critical to restore liquidity, and enhance the stability of our financial system.

As recent developments have demonstrated, the market turmoil is a global event. Governments around the world have taken actions to address financial market developments and international cooperation and coordination has been robust. It is critical for governments to continue to take individual and collective actions to provide much-need liquidity, strengthen financial institutions, enhance market stability and develop a comprehensive regulatory response.

We must continue to closely coordinate our actions and work within a common framework so that the action of one country does not come at the expense of others, or the stability of the system as a whole.

Central banks from around the world have acted together to provide additional liquidity for financial institutions, taking the necessary steps to support the global economy. The Federal Reserve has established swaplines with nine central banks to reduce pressures with global short term U.S. dollar markets.

Additionally, the U.S. Treasury implemented a temporary guaranteed program for the U.S. money market mutual fund industry. Here in the United States, the members of the President`s Working Group on Financial Markets, the PWG, made it clear we will coordinate the use of our existing and new authorities to restore market confidence.

Other countries are considering appropriate program, given their national circumstances, and we pledge to stay in close contact as they move forward with their plans.

I briefed my colleagues on the work we are pursuing to implement swiftly and thoughtfully the new financial rescue package. We are developing strategies to use the authority to purchase and ensure mortgage assets and to purchase equity and financial institutions, as deemed necessary to promote financial market stability.

As we develop plans to purchase equity, as in the approach we are taking to broad mortgage asset purchases, we are working to develop a standardized program that is open to a broad array of financial institutions. Such a program would be designed to encourage the raising of new private equity capital, to complement public capital.

Consistent with the legislation, any equity the government purchases through a broadly available equity program would be on a nonvoting basis, except with respect to market standard terms to protect our right as investors.

Securities investors around the world have taken measures to enhance market stability by addressing market abuse. Here in the United States, we have taken steps to protect the savings of American people by increasing deposit insurance limits, and the European Union member states have raised individual deposit limits to an E.U.-wide minimum.

The G-7 and others are working together through the Financial Stability Forum, the FSF, to ensure a comprehensive international regulatory response to the financial market turmoil. FSF Chairman Mario Dragi (ph) reported to us on the good progress that he has been making in approving prudential supervision and regulation and increasing exposure and transparency, and enhancing accounting frameworks.

I am committed to making sure this work continues. We are also committed to tackling the next steps laid out by Chairman Dragi to be done by the end of this year, and our ambitious agenda for 2009. Thank you, and now let me take your questions.

Yes?

QUESTION: Mr. Paulson, since Japan and China are the two biggest holders of U.S. treasuries, do you think it is possible the U.S. may be seeking help from these two countries?

PAULSON: We are in close coordination and communication with Japan and China and other investors around the world. And we`ve all been, I think people have been very mutually supportive. And so we work together closely. And I expect us to continue to do so.

Yes?

QUESTION: How do you ensure that deposit guarantees are consistent from one country another? What do you think of the Ireland and Greece guarantees, deposits - to provide financial (ph) guarantees to deposits?

PAULSON: Obviously, what we commented on was, there is an E.U. minimum for individual accounts. I told you what our focus is here. Individual countries are going to have different needs, and they`re going to approach the problems differently. But the point that we all emphasized is we`ve got the same objectives and as we pursue those objectives, it is very important not to pursue policies that are going to undermine global stability or other nation`s policies. And I think we`re committed to that goal.

Yes?

QUESTION: Mr. Secretary, a number of market (inaudible) were hoping that you would have a plan to secure access to funding on the part of financial institutions either by providing .

GREGORY: You are listening to Treasury Secretary Henry Paulson. He is at the Treasury Department announcing some of the elements of his plan to make direct investments on the part of the U.S. government into failing U.S. banks. It is the latest measure the administration is taking with the authority, the newfound authority from the bailout law that was passed just recently that provides all that cash, $700 billion, with which the government can make equity investments in U.S. banks to try to shore up those banks, to get the money flowing again. Mika Brzezinski is in New York. This comes at a very sensitive time, Mika, as we have been talking about. We have Dylan Ratigan from CNBC and Paul Krugman with us as well but this is a delicate time and another important step the administration is trying to take to convince, not just the markets but indeed, banks around the world and businesses to be confident to keep doing business with one another.

BRZEZINSKI: A delicate time and a volatile time as well, David. Dylan tells me, actually, this has been the worst week in the history of the Dow and today the most volatile day in history. So Dylan Ratigan, my question to you is what does this say about the bailout package and the benefits that were being predicted?

RATIGAN: What it says is it hasn`t kicked in yet. What it says is this problem is larger than that bailout package. What it says is that when you attach risk to a multi-trillion-dollar marketplace, which is what American and global banks did, they were basically leveraging themselves to the house of every house in America. Imagine if I could attach your bonus, Mika, to the price appreciation of every home in America. As those houses went up, I could pay you hundreds of millions of dollars. But when those houses flipped over and started to go down, you don`t have the money to incur that risk. The market has come to the realization that a system was allowed to be created that allowed for exactly that and as a result, you have the most precipitous drop in the equity markets ever and the most volatile day ever. The markets coming to terms with the fact, a system that was created that was phenomenally dangerous.

GREGORY: Dylan, thank you. This is David again at the White House. I want to pick up with Paul Krugman the last word here. Interpret for us in easy to understand language, what we heard from Secretary Paulson tonight and why it matters.

KRUGMAN: Well, he said basically, the plan has changed focus. He is going to buy in. It will be buying stakes in the banks, rather than taking the bad assets off their hands. Actually, in some ways, it is like a cliche. But what is really important is what he didn`t say. There was nothing in there about guaranteeing the banks` liabilities, which is the other half of what Britain announced on Wednesday. He just did half of Gordon Brown. The immediate reaction will be, wait, that`s only half the plan. Where is the rest of it? By the way, we also had the communique from the G-7 which was a disappointing document that came out just a few moments before Paulson spoke. It was vague. What we`ve just gotten is a big change in direction but still half-hearted.

GREGORY: If you say half-hearted, Paul, what is the additional step the administration could take and might take yet?

KRUGMAN: Guarantees on interbank lending. That`s what we need from the administration. We need both. We`re going to put in capital and we`ll provide temporarily, we`re going to provide some guarantees for banks lending to each other. What we want to hear from the G-7, what we want to hear from the other countries, us, too, rather than the kind of bromides that they issued in their official statement. We`re not there yet. If it doesn`t get a lot stronger in the next 48 hours, not good.

GREGORY: Quickly, Paul, to you expect the candidates to jump in in a specific way in terms of shaping policy at this stage?

KRUGMAN: No. It`s beyond -- It is hard to do politically. And look, they don`t have the resources. They`ve got smart guys, or at least Obama has smart guys around him. But they`re not capable of keeping up with this. It`s - stuff is moving too fast, you need the Treasury Department.

UNIDENTIFIED MALE: We`re going to HARDBALL.

GREGORY: Paul Krugman, thank you very much. Mika Brzezinski, thank you for all your help throughout the hour. That`s the program. A special addition from the White House tonight of RACE FOR THE WHITE HOUSE. A quick programming note before we go tonight. Be sure to tune to MSNBC next Wednesday, October 15th when John McCain and Barack Obama face off at Hofstra University. It is their third and final debate before Election Day. A very important night. Thank you for watching. Again, thanks to Mika Brzezinski for all of her help tonight. I`ll be back on Monday night, 6:00 p.m. Eastern Time. Mika will be back with you of course on MORNING JOE 6:00 a.m. on Monday.

BRZEZINSKI: I`ll be there.

GREGORY: Have a peaceful Friday night. Thank you, Mika. And stay right here. HARDBALL WITH CHRIS MATTHEWS starts right now.

Originally broadcast, 10.10.08