U.S. Plans New Bank-Capital Injections, Expanded Fed Program

By Dawn Kopecki and Rebecca Christie

Feb. 7 (Bloomberg) -- The Obama administration is considering subjecting banks to a new test to determine whether they require fresh capital injections as part of the rescue plan to be unveiled by Treasury Secretary Timothy Geithner next week, people familiar with the matter said.

The Treasury may increase its stake in lenders that are judged short of capital, the people said on condition of anonymity. Should extra taxpayer funds result in majority ownership by the government, officials would then decide whether to liquidate the institutions, place them into receivership or retire the companies’ assets over time, they said.

Officials are preparing to deploy billions of dollars more to help recapitalize the banks, after already investing an excess of $200 billion. In a second key feature of the plan, the Federal Reserve will likely expand what is now a $200 billion program to revive consumer loans, according to two people briefed on the talks. Details are still being discussed and could change.

The proposals are part of what the U.S. Treasury calls a “comprehensive” effort to shore up confidence in the financial system after more than $750 billion in credit losses. Officials are also considering ways to deal with the toxic assets clogging banks’ balance sheets, where the debate has moved away from the creation of a so-called bad bank, which some lawmakers have called too costly. Guaranteeing the securities may offer a cheaper option.

Yellen’s Lesson

“A lesson from past experience with banking crises around the globe is that the removal of bad assets from bank balance sheets, along with the injection of new capital, is needed to restore health to the banking system,” San Francisco Fed President Janet Yellen said in a speech in Hawaii yesterday.

The surge in home foreclosures is also likely to be addressed, according to House Financial Services Committee Chairman Barney Frank.

Geithner will present his plan on Feb. 9 in a speech at the Treasury scheduled for 12:30 p.m. in Washington.

“They need to get credit flowing again,” said Kenneth Rogoff, a professor at Harvard University and a former chief economist at the International Monetary Fund. “To do that they need to clear the decks somehow. The financial system is just dead in the water.”

Economy Deteriorates

Efforts to breathe life back into the banking system have taken greater urgency as reports showed the recession -- already the worst since 1982 -- is deepening. The Labor Department said yesterday that another 598,000 jobs were lost in January, driving the unemployment rate to 7.6 percent, the highest level in 17 years. As more people lose their jobs, more loans have soured and banks have become even more reluctant to lend.

President Barack Obama has warned that some banks have yet to fully reflect losses on their assets, and stress tests may offer the government a way of forcing firms to reckon with the illiquid securities. The tests model what would happen to banks in different scenarios and gauge whether they have enough capital to survive.

Geithner has for years pushed lenders to be more aggressive in assessing the vulnerability to their capital and liquidity of their trading to unexpected crises.

“More rigorous and comprehensive stress testing of large shocks across multiple markets, geographic regions and business lines is vital, particularly for systemically important institutions,” Geithner said in an April 2005 speech, when he was the president of the New York Fed.

Geithner Campaign

More recently, in responding to questions from lawmakers after his confirmation hearing last month at the Senate Finance Committee, he called for “more frequent and more focused forward-looking assessments of capital and liquidity adequacy under a range of possible scenarios.”

The S&P 500 Financials Index is down almost 50 percent since the $700 billion Troubled Asset Relief Program was enacted Oct. 3. The first half of the TARP was dedicated to injecting capital into more than 300 financial firms and bailing out automakers.

Officials have for weeks talked about how to overhaul the four-month-old $700 billion financial-rescue program, which Congress has criticized for failing so far to restart lending to consumers and businesses.

One of the main sticking points has been how to value the assets that the government could insure or guarantee -- a challenge that helped force former Treasury Secretary Henry Paulson to abandon an earlier effort at doing so last year.

Reviving Credit

Still, addressing the deteriorating investments is critical to repair the financial system and allow lenders to begin extending credit again, economists say.

Yellen, who served as White House Council of Economic Advisers chairman in the Clinton administration, warned that “as long as hard-to-value, troubled assets clog their balance sheets, banks find it difficult to attract private capital and to focus on new lending.”

One way to nurse banks back to health has been to backstop their debt. The FDIC currently has a program that guarantees some kinds of bank debt for as long as three years, and announced on Jan. 16 broad plans to expand the facility to include guarantees up to 10 years.

The agency is evaluating precisely how to expand the insurance. Temporary regulations on that extension have been delayed as Treasury and FDIC officials weigh what debt should be covered.

Fed Program

As part of Geithner’s rescue plan, the Fed may expand a new program to make it easier for consumers and small businesses to get loans.

Under the Term Asset-Backed Securities Lending Facility, announced in November, the central bank will lend up to $200 billion to holders of top-rated debt backed by “newly and recently originated” loans. Those include education, car and credit-card loans, and borrowing guaranteed by the Small Business Administration.

The program, known as the TALF, is being seeded with $20 billion of funds from the TARP to protect against Fed losses. Any additional Treasury funds may help the Fed widen the program. The Fed said yesterday it will announce a start date this month, stepping back from previous plans to begin lending in February.

Hedge funds, private equity funds and mutual funds based and managed in the U.S. are eligible to borrow from the TALF program to invest in the debt, the Fed said in updated terms and guidance on the facility.