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Treasury Weighs Hard Choices To Save Banks

At the time, Treasury Secretary Henry M. Paulson Jr. said these assets were the primary reason banks were teetering and the government needed to remove them from their balance sheets. Treasury officials began consulting experts to see whether the government could use auctions to get the best price for these toxic assets. The officials quickly came to an alarming realization: Paying this market price for the assets of one bank would force all other firms to discount the stated price of the troubled assets on their books to the same level. That could blow a hole in their balance sheets, triggering losses and precipitating the collapse of companies throughout the banking system.

To prevent this scenario, the officials concluded, the government would likely have to pay an inflated price for the assets. But paying too much, while generous to banks, could damage the government's credibility with financial markets and anger politicians.

This pricing dilemma remains the most vexing question for Obama's team, which has come to believe that the problem of toxic assets must be dealt with directly, sources said. To address the massive quantity of these assets, officials are likely to combine some funds approved by Congress with additional money from the Federal Reserve in establishing new government institutions to buy up distressed assets, the sources said.

One way to potentially relieve banks from the burden of toxic assets without buying them is for the government to guarantee the value of these holdings. This approach was adopted during the bailouts of Citigroup and Bank of America over the past three months. But the cost of providing such federal insurance could be huge and would likely require an enormous commitment by the Fed -- or an additional allocation of rescue funds by Congress running in the hundreds of billions of dollars, the sources said.

Some help from the TARP bailout, government officials said, may go to jump-starting the credit markets that finance roughly half the debt owned by businesses and households. During the boom years earlier this decade, investors bought pools of mortgages and other kinds of loans packaged into securities, providing fresh funding for bank lending. But this activity ceased after traders lost confidence that the market was accurately pricing the value of these securities and assessing their risk.

The Federal Reserve is poised to launch an initiative in coming weeks to restart a segment of these markets by offering to buy highly rated commercial paper, backed by assets such as credit card debt, student loans and auto loans. Officials are considering expanding this initiative to help free up loans for municipalities, small businesses, commercial real estate and other consumer debt.

This program would be highly complex, which demonstrates another problem facing Obama's team: All of the rescue efforts are difficult to explain to ordinary Americans, who criticize the government for spending too much money to aid financial firms that started the crisis in the first place.

The bailout program "is a public relations nightmare," one government official said. He added that Obama officials are sure to face criticism for whatever course they take.

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