By Neil Irwin and Binyamin Appelbaum
Washington Post Staff Writers
Tuesday, February 17, 2009
Just days before Treasury Secretary Timothy F. Geithner was scheduled to lay out his much-anticipated plan to deal with the toxic assets imperiling the financial system, he and his team made a sudden about-face.
According to several sources involved in the deliberations, Geithner had come to the conclusion that the strategies he and his team had spent weeks working on were too expensive, too complex and too risky for taxpayers.
They needed an alternative and found it in a previously considered initiative to pair private investments and public loans to try to buy the risky assets and take them off the books of banks. There was one problem: They didn't have enough time to work out many details or consult with others before the plan was supposed to be unveiled.
The sharp course change was one of the key reasons why Geithner's plan -- his first major policy initiative as Treasury secretary -- landed with such a thud last Tuesday. Lawmakers, investors and analysts expressed dismay over the lack of specifics. Markets tanked, and fresh doubts arose about the hand now steering the country's financial policy.
Public acceptance of the plan suffered from several missteps, said sources involved in the decision-making or in close contact with those who were.
The Obama administration, they said, failed to rein in the grand expectations built for the plan on Wall Street and in Washington, concluding that they would rather disappoint the markets with vagueness than lay out a lot of details they might have to change later -- a failing they saw in the Bush administration's handling of the crisis.
Meanwhile, the sources said, Obama's senior economic advisers were hobbled in crafting the plan by a shortage of personnel. To date, the president has not nominated any assistant secretaries or undersecretaries at the Treasury, and the handful of mid-level staffers who have started work were still finding their offices and getting their building passes and BlackBerrys.
Moreover, the department made a strategic decision to limit input from the financial industry and other outsiders, aiming to prevent leaks and avoid a perception they were designing the plan for the benefit of big banks. But that also meant they were unable to vet their plan with the companies involved or set realistic expectations of what would be announced.
Though Geithner had been in his job for only two weeks, he had been thinking about the problem of troubled assets since the credit crisis erupted 19 months earlier, first as president of the Federal Reserve Bank of New York and then, since November, as Barack Obama's pick to head the Treasury.
His predecessor atop Treasury, Henry M. Paulson Jr., had drawn political fire after he unveiled the Bush administration's $700 billion bailout program in September, facing accusations that the money had been spent erratically.
Geithner, while still at the New York Fed, had been deeply involved in the discussions over crafting Paulson's program. The effort may have arrested a potentially devastating financial panic, but he sought to improve on its implementation by developing a more systemic plan for using billions of dollars, sources said.
Quickly, discussions got underway. Geithner set a Feb. 9 date to release a plan, creating an artificial deadline meant to focus internal debate and prevent an overly
prolonged period of what might come across publicly as indecisiveness.
At the center of the deliberations with Geithner were Lawrence H. Summers, chief White House economic adviser; Lee Sachs, a Clinton administration official likely to be named undersecretary for domestic finance; and Gene Sperling, another former Clinton aide. The debates among them were long and vigorous as they thrashed countless proposals and variations. Sometimes, Fed Chairman Ben S. Bernanke, Federal Deposit Insurance Corp. Chairman Sheila C. Bair and Comptroller of the Currency John C. Dugan joined in.
The team concluded that the financial rescue effort would have to include several components. None would be more vital than an initiative for either removing or neutralizing the distressed assets on the banks of books -- many related to troubled mortgages -- so the banks would be freed to resume lending.
Senior economic officials had several approaches in mind, according to officials involved in the discussions. One would be to create an "aggregator bank," or bad bank, that would take government capital and use it to buy up the risky assets on banks' books. Another approach would be to offer banks a government guarantee against extreme losses on their assets, an approach already used to bolster Citigroup and Bank of America.
As the first week of February progressed, however, the problems with both approaches were becoming clearer to Geithner, said people involved in the talks. For one thing, the government would likely have to put trillions of dollars in taxpayer money at risk, a sum so huge it would anger members of Congress. Officials were also concerned that the program would be criticized as a pure giveaway to bank shareholders. And, finally, there continued to be the problem that had bedeviled the Bush administration's efforts to tackle toxic assets: There was little reason to believe government officials would be able to price these assets in a way that gave taxpayers a good deal.
By Wednesday, Feb. 4, Geithner was leaning toward a different approach that his former colleagues at the Federal Reserve had developed months earlier, the source said. This involved a joint public-private fund to buy up the assets. Private investors, likely hedge funds and private-equity funds, would put up capital, and the government would loan money to the fund. If the private investors made wise decisions about which assets they bought, they would be able to pay back the government and make money for themselves.
For the policymakers, the chief appeal of the public-private partnership is that it solves the problem of how to price assets. The private money managers who provide capital for the fund would decide which assets to buy, and at what price, taking government bureaucrats out of that difficult task.
Moreover, the private contribution lowers the total amount of money the government would need to put at risk. Also, the government would require private investors to incur any losses before the government does, reducing taxpayers' exposure to potential losses (but also potentially depriving them of any windfall profits).
But there were multiple complications: How much government financing would be needed? What other incentives would be needed to get private firms on board? Where would the government get the money? What assets would the fund buy? Would the government have a say in which banks they're bought from? Might there be more than one fund?
The clock was ticking. But Geithner wasn't ready to share his thoughts with senior government officials outside his narrow circle. He and his team worked on the plan through the weekend, with some of his staff working until 4 a.m. The team grew to about 20 officials, including lawyers, finance experts and public affairs staff.
One key element of the Treasury's new plan was to conduct "stress tests" of the 20 or so largest banks, figuring out what would happen to them if the economy worsens significantly more than most analysts forecast.
The information gathered from that process could help shape the public-private fund, said an administration source. But many in the banking industry are unclear what information the government could access beyond that already available to bank regulators or to Geithner himself, who until recently had been the chief regulator of the country's largest banks as the head of the New York Fed.
On Saturday, Feb. 7, the officials won a slight reprieve when the White House asked that Geithner's speech be postponed from Monday to Tuesday to allow Congress to focus a little longer on the on the massive economic stimulus package still pending.
But there still was not enough time to sculpt the detailed plan that the financial markets expected. In the end, Geithner and his colleagues decided that it would be better to take flak for being vague than publicly offer half-formed details that might later have to be revised. And ambiguity, the officials concluded, would make the plan an easier sell on Capitol Hill, as congressional leaders could be brought into the discussions of details rather than be presented a detailed plan as fait accompli.
Staff writers Lori Montgomery and David Cho contributed to this report.