Bailout Talks Turn to More Equity Stakes

By DEBORAH SOLOMON WASHINGTON -- The Obama administration's financial-rescue plan is shaping up to include capital injections with tougher terms than the first round and an expansion of an existing Federal Reserve lending facility that could potentially buy up toxic assets clogging the system, according to people familiar with the plans. The discussions are still fluid and much could change. But efforts to create a so-called bad bank to purchase distressed assets and to insure other assets against future losses appear less central to the administration's thinking. Still, some within the administration continue to push those efforts and they could wind up as part of the plan that will be detailed Monday by Treasury Secretary Timothy Geithner. Getty Images The Obama administration's financial-rescue plan is shaping up to include capital injections with tougher terms than the first round. To deal with the toxic assets at the heart of the financial crisis, the administration is considering expanding the Fed's consumer-lending facility, known as the Term Asset-Backed-Securities Loan Facility. The TALF was set up to spur the consumer-loan market by having the Fed lend up to $200 billion to investors who buy securities backed by car loans, credit card debt, student loans and small business debt. The Obama administration is discussing expanding the TALF to provide financing for other older assets, such as mortgage-backed securities. Also under discussion is another round of capital injections that would carry stricter terms and likely be used by weaker banks in need of money instead of the healthy banks that were targeted in the first round. Instead of buying preferred shares, as it did before, the government is discussing taking convertible preferred stakes that automatically convert into common shares in seven years. Such a move could help banks as they look for ways to bolster common equity. When a bank takes a loss, it has to subtract that amount from the value of its common equity. As losses mount, investors increasingly believe banks need to find ways to shore up this first line of defense on their balance sheets. To get money, banks would likely have to pay a higher dividend to the government than the 5% rate the government charged in the first round of infusions and agree to a host of new restrictions, such as lending above a baseline level, reporting frequently on their use of the money and curbing executive salaries. While Treasury wouldn't preclude healthy banks from participating, the stricter terms would likely attract primarily weaker banks in need of capital. The efforts are expected to be combined with a broad foreclosure-prevention program that would spend $50 billion to $100 billion to help homeowners in danger of losing their homes. The evolving discussions reflect the difficulties facing the Obama administration as it endeavors to come up with a new look for the maligned financial bailout. It wants to create a comprehensive plan that appears different from the one crafted by the Bush Treasury, but is running into many of the same thorny questions encountered by former Treasury Secretary Henry Paulson, such as how to value the bad assets owned by banks. The administration has also been wrestling with how to help resolve the financial crisis while not appearing to bail out banks at the expense of taxpayers. The administration has been trying to find the balance by crafting programs that use taxpayer dollars but on terms that don't make it seem like a giveaway, including the executive-pay curbs announced this week. At the same time, in order to revive the financial system, the administration needs to create a program that encourages banks to participate. That tension has been one of the complicating factors in creating a so-called bad bank to buy up toxic assets from financial institutions. To help banks the U.S. needs to pay a high enough price for the assets. But lawmakers are already angry about accusations that Treasury overpaid for assets and the Obama administration wants to avoid being seen as bailing out banks at the expense of taxpayers. If the government pay too little, banks would have to take further losses. The discussions have shifted several times. As recently as last week, the apparent centerpiece of the revamped plan was a "bad bank" and an insurance program to protect losses on the remainder. Both ideas may still be included. Fed and Treasury officials have said since announcing the TALF program in November that it could be expanded to include other asset classes. But the program is untested and hasn't yet been launched. Finalizing the details of the plan have proved challenging. Under the program, investors, including many hedge funds, would get cheap, nonrecourse financing from the Fed which they would use to buy asset-backed securities tied to auto loans, credit card debt student loans and small business loans. Officials are still sorting through the terms they would offer. A report issued by the Treasury Department's inspector general Thursday warned the TALF program was potentially vulnerable to private-sector fraud unless it included tough safeguards. —Jon Hilsenrath contributed to this article. Write to Deborah Solomon at deborah.solomon@wsj.com