Sunday, March 22, 2009

The Obama administration’s latest plan to help banks get credit flowing again is drawing a tepid reaction from investors and academics, who say the proposal comes with too many strings attached and is unlikely to stimulate lending industrywide.

And even if banks are willing to start lending more money, they wonder if many people will be able to take on more credit until the economy gets going again.

“We went on a borrowing binge,” said Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors. “Debt levels, especially in households, are too high or unmanageable.”

The plan Treasury Secretary Timothy Geithner intends to announce Monday aims to create a new government entity _ the Public Investment Corp. _ to help buy up to $1 trillion in toxic assets on banks’ books.

The initiative will seek to entice private investors, including big hedge funds, to participate. It will do so by offering billions of dollars in low-interest loans to finance the purchases and by sharing risks if assets fall further in value.

Analysts agree that stabilizing the banking system is crucial. But some wonder whether the proposal will create more problems.

“It’s quite possible we could make bad banks out of good banks,” Sung Won Sohn, professor of economic and finance at the Smith School at California State University, said Sunday.

Sohn wonders whether the sale of assets at bargain prices, to remove them from banks’ balance sheets, would then force other banks to have to write down the value of similar assets they might not want to sell. He suggests it might be better if the government offered insurance that banks could buy to protect the toxic assets or offered some sort of loan guarantees.

Sohn and others also question whether hedge funds and other investment groups will want to get involved for fear that doing so will make them targets of new government regulation down the road. Sohn noted that Congress is considering a bill to impose a 90 percent tax on millions of dollars in employee bonuses paid by American International Group Inc. and other bailed-out firms.

“It’s very hard as an investor to take money into a plan with the government and sit and wonder if the government will change the song sheet midway,” said Quincy Krosby, chief investment strategist with The Hartford.

“It’s now to the point that you literally don’t know what they want to do,” she said of Congress.

Meanwhile, in trying to encourage lending, the government must take great care to avoid distorting incentives, said Robert Webb, a finance professor at the McIntire School of Commerce at the University of Virginia.

“Do you want to lend to bad creditors in a bad economic environment?” he asked.

Webb also said potential investors may be put off by the uncertainty over how a true market price will be set on some of these assets and over what guidelines will be used to determine how losses and profits get shared.

Johnson believes the process of allowing banks to continue to write down the value of loans should be allowed to continue. The government should step in only to keep the process going in an orderly way or to prevent the failure of a large institution, he said.

But even if the program works to free up money, some analysts also wonder who would lend it right now and assume potential losses when the economy is so poor. They also question whether many people can afford to take on more loans given how much debt families and businesses already are carrying.

Johnson noted that households that are worried about job losses are increasing their savings and reducing spending until the economy turns around.

“Households have very little appetite to increase their borrowing,” he said.

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