Geithner faces next hurdle

Bloomberg

U.S. Treasury Secretary Timothy Geithner’s plan to remove banks’ distressed assets cleared its first hurdle, triggering the fourth-best day for U.S. stocks since the 1930s on Monday. The next hurdle: showing results soon enough to convince a skeptical Congress to approve more money.

With regulators scheduled to complete their review of banks’ capital needs by the end of next month, the Treasury may need to seek $750 billion or more to offset writedowns on the loans and securities, analysts say. The Obama administration’s task will become even more difficult if the Geithner plan isn’t perceived to be working by then.

After the furor over bonuses paid to American International Group executives, the administration must "get Congress to turn down the heat on the financial sector," said Vincent Reinhart, a scholar at the American Enterprise Institute. "That will require that the White House use its approval rating to convince the American people that Wall Street can be part of the solution."

Under the plan Geithner outlined on Monday, the Treasury will provide $75 billion to $100 billion for an initiative dubbed the Public-Private Investment Program that will finance private investors’ purchases of devalued loans and securities. The program’s initial objective is $500 billion, and it could be expanded to $1 trillion, the administration said.

The Standard & Poor’s 500 Financials Index soared 18 percent on Monday, helping drive a 7.1 percent advance in the broader S&P 500 Stock Index, the fourth-biggest gain since the 1930s. The reaction to the administration’s announcement helped erase most of the losses since Geithner’s initial outline on Feb. 10 spurred criticism from investors for its lack of detail.

If Geithner follows through on picking asset managers in coming weeks to run funds that will buy distressed debt, he would succeed where former Treasury Secretary Henry Paulson failed.

After Congress approved the $700 billion financial-rescue fund in October, the Treasury for weeks sought to hire private managers and set up a system of government purchases of the securities. Paulson abandoned that attempt in November. Geithner plans to hire five asset managers by May.

Rescue allocations

The $700 billion rescue program is mostly in the form of loans and investments that are supposed to be repaid.

A further gauge of initial success could come from a Federal Reserve program providing loans to investors in new securities backed by loans and assets. Officials want to expand the program, the Term Asset-Backed Securities Loan Facility, to include older, devalued securities. Policy makers hailed the TALF’s start last week for catalyzing about $9 billion of deals.

The administration’s plan also includes an initiative to purchase whole loans from banks, which will be overseen by the Federal Deposit Insurance Corp. As with the asset managers for the distressed securities, the Treasury will provide matching capital to investors. The FDIC will offer debt guarantees of up to six times the capital provided.

By employing private investors, the administration is betting it can avoid the strategy advocated by Nobel laureate Paul Krugman and ex-Treasury Secretary James Baker of the government taking over banks loaded with toxic debt. Geithner also seeks to address devalued assets, rather than leave them on balance sheets as Japan did in the 1990s at the cost of economic stagnation.

"Geithner’s plan is very much in the middle," Adam Posen, deputy director of the Peterson Institute for International Economics in Washington, said in an interview. "The Treasury is putting itself through conniptions, trying to find out a way to do this without going to Congress to ask for money or nationalizing the banks."

Professor Nouriel Roubini projects $3.6 trillion of losses on U.S. loans and securities, including writedowns on $10.84 trillion of securities and losses on a total of $12.37 trillion of unsecuritized loans. Former Fed Chairman Alan Greenspan said last week that banks will need more than $750 billion in fresh capital, either from the government or private investors. President Barack Obama’s budget for 2010 also included a "placeholder" for an extra $750 billion in rescue funds.

Such sums would likely meet with congressional resistance. "The American people are not interested in committing even more of their grandchildren’s money to another bailout," said Representative Tom Price of Georgia, who leads a group of fiscally conservative Republicans in the House.