A sharper outline for bank rescue plan

Bank stocks get a double-digit bump after Obama team’s communications blitz.

By , Staff writer

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    Obama (l.) and his economic team rode forth this week to persuade Americans and investors that a banking apocalypse is not at hand. Here, Treasury Secretary Tim Geithner (c.) and Budget Director Peter Orszag listened to the president speak about his fiscal 2010 federal budget on Thursday in Washington.
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For President Obama and other federal officials, this has been a week of pushback against criticisms that their efforts to defuse the financial crisis are weak or unclear.

In a series of public appearances, they have sharpened their explanations of why they hope to avoid outright takeover of weak banks, why it is in the public interest to put more government money into those banks, and how to reshape regulations in the hopes of preventing a repeat of the current crisis.

In effect, four horsemen rode forth to persuade Americans and investors that a banking apocalypse is not at hand: Mr. Obama, Federal Reserve Chairman Ben Bernanke, Treasury Secretary Timothy Geithner, and Sheila Bair, chairman of the Federal Deposit Insurance Corp.

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The communication offensive had a positive effect on bank stocks. On Thursday morning they were up by double-digit rates over where they stood last Friday after a punishing week.

Financial experts say the path through this banking crisis will not be easy or inexpensive, however, and nothing this week has changed that view. And despite the official avowals that banks should remain in private hands, it’s possible that something close to government ownership will occur at some large institutions.

“The US banking system as a whole is capital-impaired” and needs an infusion of money one way or another, says Brian Bethune, a financial economist at IHS Global Insight in Lexington, Mass. “If you don’t allay the … uncertainty then all that does is generate a speculative frenzy like we saw [in bank stocks] last week.”

Fed Chairman Bernanke, while independent from the Obama administration, offered the words that may have affected markets most strongly this week. He aligned himself with Mr. Geithner’s view that it is far better to assist banks, while leaving them in private hands, than to place them for a time under outright federal ownership.

“Call it a public-private partnership,” Mr. Bernanke told a Senate hearing. “It’s not nationalization, because the banks would not be wholly owned or probably not even majority owned by the government. The government will be a shareholder, along with private shareholders.”

Bernanke warned that if the government were to take over a major bank, the process of cleaning it up and moving it back into the private sector would not be cheap or quick.

The costs could be high, in part because the bank’s value as a franchise might be diminished as business migrated to rivals not under federal control, he said. He also countered the view, held by some economists, that the most troubled large banks are effectively insolvent.

“I think ‘zombie’ was not an appropriate description for any of the banks,” he replied to one questioner. “I think they all have substantial franchise value. They’re all lending. They’re all active.”

Even as Mr. Bernanke spoke, the major bank Citigroup was in talks with the Treasury Department to boost its capital position by converting some prior federal infusions from preferred shares into common stock – a move that would raise the amount of high-quality capital.

Many analysts say Citi and other large banks will need additional capital in the weeks or months ahead, due to loan losses that have risen in the recession.

Citi and insurance company AIG are cautionary tales of how hard it can be for the government to support large troubled institutions.

The Obama team is arguing that, as costly as it may be, its plan is better than the alternative.

The administration’s overall plan begins with a thorough review of the health of major banks, after which the Treasury will inject capital as needed to keep them functioning. The aid would come with the condition that they use the money to keep credit flowing.

In return, the government would get an equity stake in the firms. But the Treasury hopes to minimize its common-stock position. In many cases that position may remain at zero, because the initial equity would come in the form of preferred shares, which are more like bonds than regular stock.

Those shares could be converted into common shares to allow the bank to maintain capital levels required by regulators. Even then, the goal would be for the government’s stake to remain below 50 percent ownership.

A second part of the plan involves creating a public-private investment fund to purchase some bad loans from banks, allowing them to clean up their balance sheets.

On Tuesday night, in a televised address, Obama himself became lead spokesman for this plan.

“It’s not about helping banks, it’s about helping people,” he said. He acknowledged that many Americans are angry about seeing federal dollars used to prop up banks, but he called lending the “lifeblood” of the economy, and said the only way to maintain that flow of credit is to help banks.

Without this, “our recovery will be choked off before it even begins,” Obama said. Officials made clear that even with little or no common stock, regulators will have significant influence over what banks do. In an interview on PBS, Geithner said new capital for banks will come with conditions that not only keep credit flowing, but create an exit strategy for public support as confidence in the system recovers.

“We want the terms designed so that, as conditions normalize, our support is expensive and unattractive,” Geithner said. “These firms will have a big incentive to go out and get private capital to replace the government’s capital as soon as possible.”

The FDIC’s Ms. Bair also appeared on TV to defend the plan and reassure people that their bank deposits are safe.

In the end, though, many difficult choices still lie ahead for banks, such as where to draw the line on which banks are “too big to fail.” The FDIC has already taken over more than a dozen weak banks this year and transferred their operations to stronger private banks.

And costs are rising. Obama said bank rescues will probably require more money than the $700 billion Congress has set aside so far.

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