U.S. Eyes Two-Part Bailout for Banks

By DAMIAN PALETTA, JONATHAN WEISMAN and DEBORAH SOLOMON The nation's top economic officials are discussing a new way to stabilize the financial system by buying a portion of banks' bad assets and offering guarantees against future losses on some of the remainder, in an effort to help banks while trying to mitigate the cost to taxpayers. Barack Obama This approach, which merges two competing ideas, was discussed this week at a meeting that included Treasury Secretary Timothy Geithner, Federal Reserve Chairman Ben Bernanke and Federal Deposit Insurance Corp. Chairman Sheila Bair, according to people briefed on the meeting. The emerging plan comes as the administration seeks to jolt the economy with an $819 billion stimulus plan and a series of additional moves designed to stem foreclosures, overhaul financial regulation and get credit flowing again. Amid that flurry of activity, President Barack Obama stepped up his rhetorical attacks Thursday on the same banks his officials are planning to aid. Summoning reporters after a closed meeting with Mr. Geithner, Mr. Obama blasted earlier news that Wall Street had paid out $18.4 billion in bonuses, calling it "the height of irresponsibility" and "shameful." "There will be time for them to make profits, and there will be time for them to get bonuses," he said. "Now is not that time." The tough talk suggested a firmer stand from the administration in its oversight of banks. But it also had a political purpose: eliciting support for an expensive and unpopular bailout program that will likely require more cash from Congress. The latest bank-aid discussions represent one idea of several being contemplated by officials, who stressed that conversations are fluid and much could change. In addition, there have been disagreements among officials as to the best approach. Ms. Bair, for example, wanted the government to buy a larger amount of bad assets, but Treasury officials worried about the expense, according to people briefed on the matter. The Obama administration has been working to craft what it calls a "comprehensive" approach to the financial crisis after months of ad hoc rescues. The decision on banks will be coupled with a broad program aimed to prevent foreclosures, White House aides say. Besides the stimulus bill and an overhaul of the financial regulatory system, officials are working on a plan to stabilize domestic auto makers. Mr. Obama called his stimulus plan "only one leg of the stool," adding that the other elements "will be rolled out systematically in the coming weeks, so that the American people will have a clear sense of a comprehensive strategy designed to put people back to work, reopen businesses and get credit flowing again." Lawrence Summers Mr. Obama met with former Federal Reserve Chairman Paul Volcker Wednesday to begin work on the regulatory overhaul. House Financial Services Committee Chairman Barney Frank (D., Mass.) said Thursday White House aides want a legislative plan ready for the meeting in London on April 2 of the Group of 20 developed and developing nations. The Treasury, under the auspices of former Secretary Henry Paulson, has already committed $335 billion to help financial institutions. Mr. Obama's aid to homeowners could cost between $50 billion and $100 billion, and the so-called bad bank that would buy up assets could ultimately reach a size of $2 trillion, according to people familiar with the matter. The central question facing policy makers: How does the government help banks exorcise their bad bets? For many of these assets, there is no current market price. If the government buys the assets for more than they are ultimately worth, taxpayers will take the hit. If the government pays too little, banks will have to record losses on other similar assets, exacerbating the problem. Under the concept being discussed, the government "bad bank," possibly run by the FDIC, would buy only assets banks have already marked down heavily. This could avoid crushing the value of other assets held by banks. It could also potentially sidestep the pricing dilemma because banks have already recognized the low value of the assets being purchased. Mr. Geithner discussed the latest idea Wednesday afternoon at the meeting with Mr. Bernanke, Ms. Bair and Comptroller of the Currency John Dugan, people familiar with the matter said. Mr. Geithner met with his staff throughout the day Thursday and with Mr. Obama in the afternoon. The remaining troubled assets -- likely a sizable amount -- would be covered by a type of insurance against future losses. This would apply to mortgages, mortgage-backed securities and other loans that banks are holding until they mature. Banks have probably given these assets an overly optimistic value because they plan to hold them. This would be similar to a structure set up recently to protect Citigroup Inc. and Bank of America Corp., in which the government and the bank would share future losses on a set pool of assets. In addition, the Treasury is also likely to make more capital injections into banks. The plans under discussion suggest Washington expects Wall Street to pay a higher price for being bailed out. Mr. Obama's excoriation of Wall Street executives came a day after New York State Comptroller Thomas P. DiNapoli estimated that Wall Street firms paid $18.4 billion in cash bonuses last year to employees living in New York City. That represents a 44% decline from 2007; but that securities firms are issuing bonuses at all has fanned criticism Wall Street is disconnected from political and economic reality. Timothy Geithner Many banks have already said they won't pay 2008 bonuses to top executives. Some financial institutions, such as Citigroup and UBS AG, also are instituting a "clawback" provision that will allow a company to recoup payments under certain circumstances. On Thursday, UBS told managing directors in its U.S. investment-banking unit that they will get no cash bonuses for 2008. In crafting an approach that covers the broad spectrum of the financial crisis, the White House is attempting to navigate a course between economists who say the president is doing too little and those saying he is trying to do too much. The incremental approach has not worked, said Sen. Charles E. Schumer (D., N.Y.) in an interview, but the risks of moving forward all at once are high. "A death of a thousand cuts is a very bad way to go," Mr. Schumer said, "but every one of the comprehensive solution has major problems." Both possible solutions to banks' woes are largely untested during a severe economic downturn. The bad-bank idea is similar to the Resolution Trust Corp., which was created to help clean up the savings-and-loan crisis. But the RTC only dealt with assets accumulated from failed institutions, not struggling ones. And the insurance aid for Citigroup and Bank of America is relatively new, and the ultimate cost to taxpayers is not known. William Seidman, who led the FDIC and RTC during the savings-and-loan crisis, says the government could end up cobbling together too many initiatives that don't fit together. "This is a horse designed by a committee and it looks like a camel," he says. Each leg of the administration's approach depends on one of the others. Consumers may do little with their stimulus cash if they are threatened by foreclosure or can't get a loan from the bank, for example. Administration officials also say a rescue of the financial system won't be complete until they can assure investors that a stronger regulatory system will prevent another financial collapse. Some economists worry the White House will create pieces of the puzzle that will ultimately be too weak. "You have to decide, 'Should I pay Peter? Should I pay Paul?' You do have to make some choices here," says Martin Baily, a former chairman of the White House Council of Economic Advisers under Bill Clinton. Mr. Baily and others have cautioned that tackling a financial regulatory overhaul in this environment, with so many other initiatives under way, will add uncertainty to the financial sector. Kevin Hassett, director of economic policy studies at the conservative American Enterprise Institute, sees the opposite problem. He says the administration should be doing more. As they confront the immediate economic crisis, for example, Obama aides have taken off the table a concurrent effort to solve long-term problems with the tax code and with Social Security and Medicare -- both of which the White House has pledged to tackle eventually. "They're not being ambitious enough," says Mr. Hassett. Write to Damian Paletta at damian.paletta@wsj.com, Jonathan Weisman at