- The Washington Times - Friday, January 30, 2009

The Obama administration is leaning toward setting up a “bad bank” that would buy toxic loan assets from large troubled banks such as Citigroup in a major new program that would be run by the Federal Deposit Insurance Corp. and is likely to cost at least $1 trillion.

The program could be announced as early as Monday as part of a comprehensive plan to address burgeoning housing foreclosures and credit problems, said banking and federal officials familiar with the administration’s deliberations.

Senate Banking, Housing and Urban Affairs Committee Chairman Christopher J. Dodd, Connecticut Democrat, told reporters Thursday that the “bad bank” would be part of a “combination of ideas” to deal with the twin crises in the banking and housing markets, adding that he “wouldn’t be surprised” if the Obama administration initially funded it out of the $700 billion Wall Street bailout program.

In light of the soaring costs of the bank bailout for taxpayers, Mr. Dodd also joined President Obama in lambasting Wall Street executives for giving themselves $20 billion in bonuses last year, the same as they received in 2004 when the economy was booming.

“That is the height of irresponsibility. It is shameful,” Mr. Obama said, noting that his administration has moved to prevent Citigroup, a major bailout beneficiary, from purchasing an expensive private jet with taxpayer funds. “Part of what we’re going to need is for the folks on Wall Street who are asking for help to show some restraint and show some discipline.”

Vice President Joseph R. Biden Jr. said of the executives: “I’d like to throw these guys in the brig. … They’re thinking the same old thing that got us here: greed.”

Mr. Biden told CNBC that the administration initially would fund the “bad bank” program by using the second half of the bailout released by Congress earlier this month. But it would seek more money from Congress if the roughly $350 billion of uncommitted bailout funds proves insufficient.

“Once we do that and see whether we can get this system kick-started, the credit system flowing more, that’s when we’ll make the judgment whether or not anything else is necessary,” Mr. Biden said.

Sen. Charles E. Schumer, New York Democrat, said the cost of a government-run “bad bank” that would purchase souring loan assets from struggling banks would run between $1 trillion and $4 trillion.

How much the new “bad bank” program will cost depends on how many banks participate and how much the government pays for the deteriorating loan assets, among other factors. Bank losses from bad loans - mostly defaulting subprime and exotic mortgages - are estimated at between $2 trillion and $4 trillion, and have been growing with each day the recession deepens.

“Various experts say a full ‘bad bank’ ends up being about $3 trillion,” Mr. Schumer said, an amount considered too great by either the administration or Congress to seriously consider. That is why lawmakers are looking at more limited solutions that would address only the problems of money-center banks considered too big to fail.

“A ‘bad bank’ is one solution, but every time you look at the solution from 10,000 feet, they’re appealing,” Mr. Schumer said. “Then when you look at the details, they’re very difficult to work out. There is no easy solution here given how large this mess is.”

Treasury Secretary Timothy Geithner met with Federal Reserve Chairman Ben S. Bernanke, FDIC Chairman Sheila Bair and Comptroller of the Currency John C. Dugan on Wednesday to consider actions.

With an eye on controlling costs, the Federal Reserve has proposed a “hybrid” approach, where the FDIC acts as a “bad bank” and purchases loans that have been pooled and packaged into securities for sale, while the Treasury and Fed provide limited guarantees on souring loans that banks plan to hold in their portfolios until they mature.

The use of guarantees helps to limit the upfront costs of the program but has not proved successful in past attempts to stem the banking crisis. Treasury already has provided such limited guarantees on about $400 billion of nonperforming loan portfolios as part of second-stage bailouts of Citigroup and Bank of America in the past two months.

The loss-sharing on the loans came with additional capital infusions of $45 billion, but in part because the bad loans remained on the companies’ books it did not prevent further deterioration of the banks’ outlook or a renewed run on their stocks.

Moreover, big banks’ stocks have sunk dramatically in recent weeks in part because of fears on Wall Street that further government aid in exchange for an increased ownership interest for taxpayers will lead to a de facto nationalization of the banks that disenfranchises stockholders.

Many Wall Street executives say a “bad bank” program is better than what they term an “insurance wrap” from the Treasury because it is the only way to permanently rid the banks of the toxic assets that have prevented them from further lending.

“Those in favor of the wrap approach suggest that Treasury dollars are more easily leveraged,” but if it doesn’t work it’s just a big waste of money that delays the “day of reckoning,” said Joshua Rosner, managing director at Graham Fisher & Co.

The cost of setting up a “bad bank” could be limited by restricting it to buying “only troubled assets of troubled banks,” rather than opening it up to all the souring assets of thousands of otherwise healthy small and medium-sized banks nationwide, he said.

“The vast majority of state-chartered banks and community banks are able to handle their currently troubled assets,” he said. “It is primarily a small number of large institutions overseen by federal regulators that are most troubled. This means the immediate focus should be on these banks.”

One area where all the regulators now agree, Mr. Rosner said, is that the government should not pay banks face value for the loans, but should discount them dramatically to reflect rising defaults and the lack of investor interest. However, regulators will not discount the loans as sharply as private buyers have recently because the government is not aiming to reap a big profit when it eventually repackages and resells the loans.

Another advantage of the “bad bank” proposal is that by obtaining ownership of the defaulted loans, the government would be in a position to order banks to work out repayment plans with defaulted homeowners to avoid foreclosures. Then, the government could package the renegotiated loans into new securities for sale to investors. That way, the government ultimately might recoup much of the cost of the program.

Preventing foreclosures has been a primary goal of Congress and would greatly increase the appeal of the program when it is presented to legislators.

• David R. Sands contributed to this report.

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