Bailout designed by Geithner

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Richard Moore

Feb 10, 2009, 7:41:45 AM2/10/09

Geithner Said to Have Prevailed on the Bailout

WASHINGTON— The Obama administration’s new plan to bail out the nation’s banks was fashioned after a spirited internal debate that pitted the Treasury secretary, Timothy F. Geithner, against some of the president’s top political hands.

In the end, Mr. Geithner largely prevailed in opposing tougher conditions on financial institutions that were sought by presidential aides, including David Axelrod, a senior adviser to the president, according to administration and Congressional officials.

Mr. Geithner, who will announce the broad outlines of the plan on Tuesday, successfully fought against more severe limits onexecutive pay for companies receiving government aid.

He resisted those who wanted to dictate how banks would spend their rescue money. And he prevailed over top administration aides who wanted to replace bank executives and wipe out shareholders at institutions receiving aid.

Because of the internal debate, some of the most contentious issues remain unresolved.

On Monday evening, new details emerged after lawmakers were briefed on the plan.

It intends to call for the creation of a joint Treasury and Federal Reserve program, at an initial cost of $250 billion to $500 billion, to encourage investors to acquire soured mortgage-related assets from banks.

The Fed will use its balance sheet to provide the financing, and the Federal Deposit Insurance Corporation might provide guarantees to investors who participate in the program, which some people might call a “bad bank.”

A second component of the plan would broadly expand, to $500 billion to $1 trillion, an existing $200 billion program run by the Federal Reserve to try to unfreeze the market for commercial, student, auto and credit card loans. A third component would involve a review of the capital levels of all banks, including projections of future losses, to determine how much additional capital each bank should receive.

The capital injections would come out of the remaining $350 billion in the Troubled Asset Relief Program, or TARP.

A separate $50 billion initiative to enable millions of homeowners facing imminent foreclosure to renegotiate the terms of their mortgages is to be announced next week.

Some of President Obama’s advisers had advocated tighter restrictions on aid recipients, arguing that rising joblessness, populist outrage over Wall Street bonuses and expensive perks, and the poor management of last year’s bailouts could feed a potent political reaction if the administration did not demand enough sacrifices from the companies that receive federal money.

They also worry that any reaction could make it difficult to win Congressional approval for more bank rescue money, which the administration could need in coming months.

For his part, Mr. Geithner will blame corporate executives for much of the economic crisis, according to officials. He will announce rules that require all banks receiving capital from the government to submit plans that describe how they intend to strengthen their lending programs and generally restrict them from using the money to acquire other banks until the government money is repaid.

But officials said Mr. Geithner worried that the plan would not work — and could become more expensive for taxpayers — if there were too much government involvement in the affairs of the companies.

Mr. Geithner also expressed concern that too many government controls would discourage private investors from participating.

A spokeswoman for Mr. Geithner, Stephanie Cutter, had no comment.

In an interview on Monday Mr. Axelrod did not deny that there were differences of opinion as the policy was being crafted or that he had taken a harder line on issues such as executive pay restrictions, as other participants to the discussions recalled. But he said he was ultimately satisfied with the final product put forward by Mr. Geithner.“We had a great and productive discussion and as a result we came up with a good set of guidelines and rules,” he said. “I didn’t come away disappointed in any way.”

The White House is hoping that its rescue plan will be perceived as a more coherent rescue effort than the Bush administration’s, and one whose breadth and scope are so vast that it begins to restore financial confidence in the battered markets and entices private investors to come off the sidelines.

The plan is calibrated to work on multiple fronts, with promises to invest billions of dollars in scores of ailing banks and creation of a new institution to relieve bank balance sheets of their most troubled assets.

It will also renew a legislative proposal giving bankruptcy judges greater authority to modify mortgages on more favorable terms to lenders and over the objections of banks.

Officials say that new rules encouraging transparency and limiting lobbying are intended to begin to restore political confidence in a program that has faced withering criticism in Congress, an effort that they view as essential because they expect to return to Congress for more money later this year.

But as intended largely by Mr. Geithner, the plan stops short of intruding too significantly into bankers’ affairs even as they come onto the public dole.

The $500,000 pay cap for executives at companies receiving assistance, for instance, applies only to very senior executives. Some officials argued for caps that applied to every employee at institutions that received taxpayer money.

Abandoning any pretense about limiting the moral hazards at companies that made foolhardy investments, the plan also will not require shareholders of companies receiving significant assistance to lose most or all of their investment. Some officials had suggested that the next bailout phase not protect existing shareholders. (Shareholders at most banks that fail will continue to lose their investment.)

Nor will the government announce any plans to replace the management of virtually any of the troubled institutions, despite arguments by some to oust current management at the most troubled banks.

Finally, while the administration will urge banks to increase their lending, and possibly provide some incentives, it will not dictate to the banks how they should spend the billions of dollars in new government money.

And for all of its boldness, the plan largely repeats the Bush administration’s approach of deferring to many of the same companies and executives who had peddled risky loans and investments at the heart of the crisis and failed to foresee many of the problems plaguing the markets.

In internal discussions, Mr. Geithner is said by officials to have raised the lessons of countries that forced banks to make loans and adopted other, more interventionist measures. Those strategies, he said, wound up costing more and undermining their governments’ credibility. He concluded the wiser course would be to provide economic incentives to encourage lending.

Some Democrats in Congress who have been given previews of the outline of the plan said it struck the right balance.

“They want to make sure the plan is a balance of carrots and sticks, which are needed substantively and politically,” said SenatorCharles E. Schumer, Democrat of New York, vice chairman of the Joint Economic Committee. “They are using every tool in the book because the problem is so vast, but they are also tailoring their response to the individual needs of each institution.”

For private institutional investors, the question of whether to invest alongside the government will depend on what kinds of carrots and sticks Treasury officials offer.

Managers of hedge funds and private equity funds are closely watching to see how much the government pushes banks to write down the value of troubled mortgages and mortgage-backed securities they want to sell.

There is no market value for most of those troubled assets because they are not trading. Investors want to buy them at the lowest price possible, but banks want to avoid selling them at rock-bottom prices and realizing huge losses.

The impasse is particularly serious for whole mortgages, which are loans that banks have kept on their own books instead of selling them to Wall Street firms, which bundle them into pools and resell them as mortgage-backed securities.

Under current accounting rules, financial institutions have already been required to write down the value of mortgage-backed securities to reflect their current market value. But banks do not have to write down the value of whole mortgages if the borrowers are still current, and many regional banks collectively hold vast numbers of those loans.

Under the category of sticks, private investment managers are closely watching how the Treasury rolls out its “uniform stress test” for grading the health of banks. If the government takes a tougher line with more banks, it could force them to sell off more of their loans and take their lumps sooner rather than later.

Under the category of carrots are various forms of financing and government guarantees.

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