In Geithner's Overhaul, Aggressive Use of All Available Tools Expected

House Speaker Nancy Pelosi met with Treasury Secretary Timothy F. Geithner, who is expected to announce a revamped financial rescue plan.
House Speaker Nancy Pelosi met with Treasury Secretary Timothy F. Geithner, who is expected to announce a revamped financial rescue plan. (By Melina Mara -- The Washington Post)
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By Neil Irwin and David Cho
Washington Post Staff Writers
Sunday, February 8, 2009

The nation's top economic policymakers were putting the finishing touches yesterday on a financial rescue plan that will deploy hundreds of billions of dollars to spur the flow of credit to consumers and businesses.

The Obama administration aims to ease the financial crisis through a series of steps -- including a program to insure banks against extreme losses on mortgages and other loans, a new round of investments in banks, help for homeowners at risk of foreclosure and the broadening of a Federal Reserve program to prop up lending. It could also purchase toxic assets from banks, possibly with financing from the private sector.

The plan amounts to an overhaul of the financial rescue undertaken by the Bush administration. It was scheduled to be announced Monday, though yesterday the administration was considering delaying it until Tuesday to maintain focus on the stimulus. No decision had been made, a source said.

The approach reflects Treasury Secretary Timothy F. Geithner's philosophy of how governments should respond to financial crises. He favors aggressive use of all available tools, both to deal directly with the massive losses in the financial sector and to bolster confidence in the future. Too little government response during a severe crisis poses a greater risk than too much response, he said at his confirmation hearing.

"There's a sense that there have been too many false starts and changes of direction," said Martin Neil Baily, a Brookings Institution senior fellow and chairman of the Council of Economic Advisers in the Clinton administration. "We need a bold and sweeping comprehensive framework that will get us through this, keeping in mind it won't turn the recession around immediately."

Yesterday, Treasury officials huddled in conference rooms, working through details, as did their counterparts at the Federal Reserve, the Federal Deposit Insurance Corp. and at other financial regulators, all of whom are likely to play a role in the rescue. Last night, many of the details of what Geithner will announce remained in flux, though the broad outlines were becoming clear.

Some of the policies he plans to announce are continuations of ideas developed under former Treasury secretary Henry M. Paulson, though with new twists.

For example, there are likely to be new government investments in banks. But so far, the investments have come in the form of "perpetual preferred" stock, and the government has extracted no real control over how banks run themselves or what they do with the money.

The new approach is likely to make the investments convertible into common stock after some fixed period of time, perhaps seven years. If the banks are unable to raise private capital in that span, the government would receive more explicit control.

Moreover, banks receiving investments will have to report to the government and to the public, and the government is likely to insist that the new capital be used to expand lending. "Public assistance is a privilege, not a right," Geithner yesterday told House Democrats at a closed-door meeting in Williamsburg, Va., according to Democratic sources.

Geithner and his team have been trying to find a way to resuscitate the original idea of the Troubled Assets Relief Program, which Congress passed Oct. 3. Paulson pitched the plan to Congress as a program to buy troubled assets off of banks' books, then changed direction and invested the money in the banks instead.

One major reason Paulson changed direction was that he concluded that asset purchases would involve too many technical complications to enact quickly. Geithner and his team have grappled with the same challenges. They appear to be settling on an approach that amounts to financial triage, meant to give investors confidence that banks will not encounter vast new losses so that they are willing to invest private money.

One major problem facing banks is that the true value of the assets they hold on their books could vary widely depending on how bad the economy gets. That uncertainty makes banks unwilling to lend, increasing the chances that the economy will get significantly worse and that the losses will be massive.

Geithner and his colleagues are hoping to break that cycle by protecting banks against the kinds of losses that would occur if the economy goes into a tailspin.

For assets that banks intend to hold until maturity, the government would offer, in essence, an insurance policy against severe future losses. This approach, called an asset wrap, has been used already for Citigroup and Bank of America. It has the advantage of stabilizing the institutions that receive the guarantees, but does not do much to restart markets for mortgage and other troubled securities.

By partnering with the private sector, the government could also create a program to buy up other toxic assets that banks hold in their trading portfolios. Outside analysts call this strategy the creation of a "bad bank," though the Obama administration resists that terminology.

The Federal Reserve and Treasury will likely announce an expansion of a program that is being created to try to jump-start lending outside the banking system. In November, the agencies launched a program, called the Term Asset-Backed Securities Loan Facility, that will devote $200 billion for credit card, auto, student and small-business loans. Its launch is expected in the coming weeks.

The Fed and Treasury are likely to enlarge that program and expand it to support lending for commercial real estate and residential mortgage loans.

Geithner could also announce a plan to inject government money into companies known as monoline insurers. These play a vital role in enabling states and municipalities to borrow money. Mortgage-related losses by the insurers has made it harder for states to issue the municipal bonds that would help them ride out the recession without aggressive budget cuts.

Geithner is likely to roll out a plan, worth $50 billion to $100 billion, to encourage the modification of mortgages for homeowners who are otherwise at risk of foreclosure. It could be based loosely on a strategy for foreclosure relief engineered by FDIC Chairman Sheila C. Bair when the FDIC took control of the failed bank IndyMac last year. Extensive details of how the plan will work may not be complete when Geithner delivers his speech, however.

"Institutions that get assistance will have to participate in loan modifications and meet other standards that we set," Geithner told the House Democrats yesterday, the sources said.

Staff writer Perry Bacon Jr. contributed to this report.

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