Washington - The Obama administration is developing proposals to help rescue the banking system that could cost taxpayers hundreds of billions of dollars beyond the $700bn bailout Congress already has approved.
Details are still being worked out. But the administration will likely propose spending hundreds of billions more to address the foreclosure crisis, buy some distressed bank assets and guarantee losses on others, according to people with knowledge of the discussions who spoke on condition of anonymity.
Looming above the proposals is a plan to set up a federal bank - dubbed a "bad bank" - that would buy troubled assets clogging banks' balance sheets. This would free the institutions to lend money and would entice wary investors back into the market, proponents say.
But the government will have to commit to far more money than policymakers had expected even a few weeks ago.
"I think we're talking hundreds of billions of dollars," said Brian Gardner, an analyst with the research firm Keefe, Bruyette & Woods. "I don't think there's anyone who doubts the administration will be going back to the Hill for more than the $350bn" recently released from this fall's $700bn bailout package.
The International Monetary Fund wrote in a report on Wednesday that losses from banks in the US and Europe have hit $1.1 trillion and could hit $2.2 trillion.
At that rate, they will require "at least half a trillion dollars" to remain solvent," the report says.
Congressional Democrats have been seeking advice from economist Mark Zandi, who is pushing a three-point plan for banks that includes more capital infusions, guarantees against losses on bad assets and a "bad bank" to buy distressed assets.
Bank stocks surge
"They should use all three of those tools aggressively," said Zandi, of Moody's Economy.com. "If they are able to establish a market-place for those assets, the benefits could be readily apparent."
The "bad bank" plan's highest-profile advocate is Sheila Bair, chairperson of the Federal Deposit Insurance.
By purchasing bad assets that banks can't sell now, the government would set prices for them. This could cost the banks dearly in write-downs. But it also could give investors clarity about the strength of the financial institutions. That, in turn, could encourage those on the sidelines to begin investing again.
"Buyers are going to say, 'Wait a minute, these are valuable assets; we just don't know how to price them,"' said Travis Larson, a spokesperson for the Securities Industry and Financial Markets Association. "Now, many of these toxic assets aren't toxic any more, because in fact, the market value has gone up as buyers re-enter the market."
Bank stocks surged on Wednesday on investor expectations about the proposed plan to purchase assets. Wells Fargo & Co soared 31%, Citigroup 19% and Bank of America 13%.
"It's pretty great news for pretty much all banks, especially the big ones," said David Stepherson, portfolio manager at Hardesty Capital Management.
Administration officials said they expect Treasury Secretary Timothy Geithner to unveil his plans for a new financial industry rescue next week.
'Pay too much and risk taxpayers'
Scott Talbott, a lobbyist with the Financial Services Roundtable, called the asset purchase plan a crucial part of the new bailout. But he said, "There's no one-size-fits-all solution to the economy. Each financial institution is in a different situation."
He said the plan will require more money than has been allocated under the initial bailout, especially given the administration's intention to spend $50bn to $100bn of the remaining $350bn to address the foreclosure crisis.
But Talbott warned that the "bad bank" plan poses big obstacles. It would be hard to set prices fairly for assets that have stopped changing hands. And the plan would require an accounting rule change to prevent a ripple effect in which all similar assets would be priced down to the government's below-market offers.
"If they pay too much, the taxpayers are at risk," he said. "If they pay too little, banks will be reluctant to sell."
And if the government doesn't suspend a rule requiring all assets to be priced according to recent trades of similar assets, Talbott said, accounting losses "would undo all the effects and push the economy deeper into recession."
The problem of pricing distressed assets led former Treasury Secretary Henry Paulson to abandon his original plan to buy troubled bank assets. Paulson decided instead to inject money directly into the banks in exchange for ownership stakes.
At his confirmation hearing last week, Geithner identified three possible methods for pricing bad assets: using computer models, asking bank supervisors to suggest values and comparing the assets to securities that are still in some demand.
None would be easy, experts said. But with a mounting sense of urgency about banks' troubles, another costly rescue attempt is unavoidable.
- AP