Detox for Troubled Assets
Tuesday, March 10, 2009
The government's plan to strip banks of troubled assets could force some firms to record large losses, but the painful purge would help restore confidence in the banking system, according to Sheila C. Bair, chairman of the Federal Deposit Insurance Corp.
Bair said yesterday that the effort might require more money than the $700 billion Congress has approved to aid the financial industry, but she added that taxpayers would probably reap an eventual profit on the asset purchases.
She said the greatest challenge was persuading banks and taxpayers to accept the necessity of the costly program.
"This takes courage to do, but if we don't do it, history shows that this kind of mechanism -- recognize the losses, get at the root of it and move on -- this is how you jump-start the economy. The other option, just to park those assets on the balance sheet, I don't think that gets us very far," Bair said in a discussion with Washington Post reporters and editors.
The government plans to partner with private investors to buy troubled assets, in part by providing financing at low cost. Bair and other federal officials said discussions were ongoing about the appropriate extent of the federal subsidy. A larger government contribution would allow investors to pay higher prices, limiting the losses that banks would record but also exposing taxpayers to greater risk.
The administration hopes to find the right balance and announce the details within the next two weeks, possibly as soon as next week, according to people familiar with the matter.
Since the early days of the crisis, plans have circulated to buy troubled assets, such as distressed mortgage loans, from banks. The Bush administration requested $700 billion from Congress to fund such a program, then instead decided to inject most of the money directly into companies. Bair said yesterday that the original plan to buy assets faltered in part because of concerns about the cost.
"What the pricing looked like, what the losses would be, I think that's what stymied this effort before," she said.
Bair, who remained in office after the election as the head of the independent FDIC, said the Obama administration appeared to understand the need for the program. She said buying troubled assets would create a clear strategy for ending the government's intervention in the banking system, something investors are eager to see.
The government's approach would involve investment partnerships with money from both private investors and the government. The government would establish multiple funds to compete with one another, creating a market that would determine prices.
Bair calls the initiative an "aggregator bank," though Treasury officials contend that the partnerships should be called "public-private investment funds."
The funds would use that capital to borrow more money, in much the way that a home buyer makes a down payment to take out a mortgage from a bank. In this case, the loan would be likely to come from the Federal Reserve. In a theoretical example, to raise $10 million, the government and the private investors might each contribute $1 million, and then borrow $8 million from the Federal Reserve. The government and private investors also could contribute different shares. Officials said the proportions remain under discussion.