Bailout Revamp Could Use Private Bank for Bad Assets

By DEBORAH SOLOMON and DAMIAN PALETTA WASHINGTON – Treasury Secretary Timothy Geithner is considering a plan to help purge banks of their bad bets by partnering with the private sector to buy troubled assets, according to people familiar with the matter. The so-called "aggregator bank" would be seeded with some money from the $700 billion financial-sector bailout fund, but most of the financing would come from the private sector. Private firms would purchase mortgage-backed securities and other troubled assets and could reap the benefits if those assets eventually rise in value. Timothy Geithner The idea is not yet certain to be included in the final plan, but appears to be a leading solution to a central problem: how does the government rid the financial system of its toxic assets. Mr. Geithner's bailout revamp has four main components: Fresh equity injections into banks; new programs to help struggling homeowners; an expansion of a Federal Reserve program designed to jump start consumer lending; and, lastly, a mechanism to allow banks to dump their bad assets. That last component has proven the most nettlesome because it's hard to know how to value assets, such as mortgage-backed securities, which rarely trade. If the government pays too high a price, banks would benefit at the expense of taxpayers. But too low a price would force banks to take further write-downs associated with those assets, exacerbating their financial woes. The administration had discussed having the government buy assets directly from banks, but the costs and complexities involved with such a plan largely scuttled that effort. News, photos and background on key players and issues in the Obama administration's first 100 days from the WSJ and across the Web. Foreign AffairsDomestic AffairsAdvisersPersonal LifeSome within the administration believe that a private-sector effort is preferable because it would allow asset prices to be set by the market instead of the government. Mr. Geithner is set to unveil the Obama administration's financial-rescue plan this week. He was expected to give a speech Monday on his plans, but Obama economic adviser Lawrence Summers said on ABC News's "This Week" Sunday that Mr. Geithner will bump his remarks to Tuesday so the Treasury Secretary can focus on the stimulus bill moving through Congress. (See related article.) The bailout plan has evolved in recent weeks as policy makers debated the merits of various approaches. The Obama administration has taken longer than some expected to finalize a plan as it sought to craft what it has called a "comprehensive" approach to replace the ad hoc initiatives of the previous administration. The Treasury secretary is expected to sell the program as a framework to address the financial crisis by attacking its root causes: defaulting loans and rotten assets that are shaking confidence in banks. Mr. Geithner met with U.S. House Democrats Saturday at their three-day policy retreat in Williamsburg, Va., and told them the U.S. financial system remains "badly damaged," said Rep. Brad Miller, a Democrat from North Carolina and a member of the House Financial Services Committee. "He said it's clearly going to get worse but we have to act to prevent it from getting much worse," Mr. Miller said. According to Democratic officials, Mr. Geithner also sough to assuage concerns that the revamp would not require aid recipients to lend the funds, one of the central criticisms of the rescue's implementation thus far. "Institutions that get assistance will have to participate in loan modifications and meet other standards that we set," he told the lawmakers. "Public assistance is a privilege not a right." The government has already committed $350 billion of the $700 billion financial-sector bailout fund approved by Congress last fall. Many economists -- and some lawmakers -- expect the administration to eventually ask Congress for more money. Other possible elements of the plan: --To improve the bailout's poor public image, the administration is considering renaming the $700 billion Troubled Asset Relief Program and making it independent of the Treasury. It is also going to announce new terms and conditions for companies that receive or have already taken government aid -- in addition to the new executive-compensation limits announced this week -- including a demand that they report how the money is being spent. --The rescue is shaping up to include a second round of capital injections with tougher terms. The government is looking to get money into banks by buying preferred shares that convert into common equity within seven years; that avoids diluting current shareholders' stakes while helping banks better withstand losses. The Treasury may also allow banks that already received capital injections to convert the Treasury's preferred shares to common stock over time. --The Treasury is considering expanding the Fed's Term Asset-Backed Securities Loan Facility to include assets beyond the student, credit-card and auto loans it was set up to absorb. The program was set up to spur the consumer-loan market by providing financing for investors to purchase securities backed by consumer loans. Another idea being considered is government insurance to limit banks' losses on certain assets. --The Obama administration is considering giving the Federal Deposit Insurance Corp. the power to help dismantle large, troubled financial firms beyond the depository institutions over which it currently has authority. Such a move could require legislation. Top government officials, including Mr. Geithner, his predecessor Henry Paulson and Federal Reserve Chairman Ben Bernanke have said there needs to be a government entity empowered to wind down failed financial institutions that aren't banks. --Regulators pointed to problems that occurred when Lehman Brothers Holdings Inc. and American International Group Inc. ran into trouble, in part because no federal body had the authority to step in and steer the firms toward an orderly demise. --The FDIC could also guarantee a wider range of debt that banks issue to fund loans, according to people familiar with the matter. The guarantees could help free up credit to companies and consumers. Currently, the FDIC temporarily backs certain debt with a three-year maturity. Government officials could move to guarantee debt with maturities up to 10 years. --For homeowners, the administration is expected to announce a plan that could include the creation of national standards for loan modifications to be adopted by mortgage giants Fannie Mae and Freddie Mac. The plan could include a mechanism to determine the value of homes facing foreclosure -- something that has proven hard to do -- which could speed negotiations with troubled borrowers. --A related move would see the government using taxpayer dollars to give mortgage companies an incentive to modify loans. One idea would help reduce interest rates by having the government match mortgage companies' interest-rate reductions to a certain amount. Mr. Geithner is also expected to express support for legislation that would allow judges to modify the terms of mortgages in bankruptcy court. With the financial crisis unabated, expectations are high for what Mr. Geithner will say. His speech will be a crucial test for the former Federal Reserve Bank of New York president, who is seeking to avoid the route taken by Mr. Paulson, whose sometimes stuttering approach to the financial rescue helped taint its reputation. "People have the expectation that something fairly bold and creative is going to be presented," said Brian Bethune, chief financial economist with Global Insight. Indeed, stock markets rallied in part this week on the belief that Washington, buoyed by worsening economic news, will find some way to fix the financial ills. Mr. Miller, the North Carolina lawmaker, said Mr. Geithner used the meeting to address the widespread anger about the Treasury's use of the first $350 billion, calling it "justified." The speech made it clear, Mr. Miller said, that the financial system remains fragile. "If we had regulators go in an examine the books like we did at Fannie Mae and Freddie Mac a great number of our systemically important financial institutions could be insolvent." Write to Deborah Solomon at deborah.solomon@wsj.com and Damian Paletta at damian.paletta@wsj.com