WASHINGTON — Treasury Secretary Timothy Geithner on Tuesday rolled out bank-rescue plan version 2.0, hoping to restore vigor to the banking sector and create a wave of new lending to reverse the nation's deep economic slump.
The plan — along with parallel economic stimulus legislation moving through Congress — amounts to a trillion-dollar roll of the dice. In addition, the Federal Reserve's muscular effort to thaw frozen credit markets is the third front of a multipart federal rescue effort. All must work in tandem to arrest the nation's economic contraction.
Geithner's plan aims to halt the soaring rate of foreclosures, thaw the deep freeze in credit markets, corral bad assets that are poisoning bank ledger sheets and perhaps allow more bank failures to weed out failing institutions.
Financial markets gave it a negative initial review. Stocks tumbled fast minutes after Geithner spoke, as traders showed frustration over insufficient details. The Dow Jones Industrial Average sank 382 points in Tuesday's trading.
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Here are some answers to questions about the Treasury plan.
Q: How will Geithner help banks?
A: The plan envisions new, limited capital injections for banks. This builds on an effort begun last year, where the federal government takes an ownership stake in banks in exchange for preferred stock and warrants, which put the taxpayer at the front of the line for repayment should a bank fail and liquidate its assets. Most economists agree that despite the $700 billion price tag on October's unpopular Wall Street rescue, more is needed.
Before banks can get more capital injections, they must undergo a "stress test" to simulate what would happen to the bank's existing capital in a variety of worsening scenarios. If more capital is needed, they would be encouraged to seek it from either private or federal sources. Treasury officials didn't put a price tag on this, but lawmakers were told in briefings that it could amount to another $100 billion.
Q: Are further capital injections a backdoor nationalization of banks?
A: To a degree, but the government is wary of taking controlling stakes and directing how banks lend and to whom. As part of the price for new capital injections, however, the Obama administration will restrict executive pay and impose greater disclosure of how these funds are used.
Q: Will giving the banks more capital work?
A: Most economists believe it's necessary. That doesn't necessarily mean it will work. Simon Johnson, a former research director of the International Monetary Fund, said Monday on a blog called Baseline Scenario that capital injections "will be too small and the measures will help existing management stay in place. Large banks will remain 'too big to fail' . . . . Lending will remain anemic." That's hardly an endorsement.
Q: Isn't it better to let these banks fail?
A: In some cases, yes — and the "stress test" is intended to create a clearer picture of whether some of the biggest banks should be allowed to fail or propped up to protect the broader financial system. The government will continue to inject capital into banks whose failure could cause systemwide risks.
Q: Banks didn't lend to consumers after the autumn bailout, so why would they do so now?
A: Hard to say. The Obama administration is demanding a greater accounting of how funds will be used and a justification if lending doesn't rise. With the economy deteriorating so fast, however, new loans become riskier, and banks are loath to make more bad loans — after failing for several years to be sufficiently prudent.
The Geithner plan aims to spark new lending by having the Federal Reserve provide a financial backstop to encourage private investors to purchase up to $1 trillion in consumer and business loans. The Fed will act as the buyer of last resort for pools of loans financing cars, student aid, commercial real estate, small business and perhaps even some large corporations.
These pools of loans are called asset-backed securities, and as recently as 2006 they accounted for 40 percent of all lending in the U.S. economy. Few private buyers want these securities, fearing that they won't be paid off. The Fed temporarily will buy these pools. About $20 billion had already been programmed for this purpose, and Treasury and the Fed will make available another $80 billion.
Q: Why did financial markets frown on Geithner's plan?
A: His plan promises a public-private partnership to help banks unload distressed mortgage bonds and other complex, hard-to-price assets that are making them fearful of issuing more loans, lest they all turn sour and consume the bank's capital. The original Wall Street bailout last October was intended to do this, but switched to injecting capital on the theory that it would be quicker. It didn't work.
Banks wanted government to buy these tainted assets at inflated prices, but Geithner's plan intends for government and private investors to share the risk. His plan doesn't answer how the assets will be priced, nor how they'll be disposed. The absence of details undermined market confidence in his plan.
Q: How would Geithner's plan help housing?
A: It includes at least $50 billion to support mortgage modifications — another fundamental component of the financial crisis. However, he and other Treasury officials offered scant details on this, too, saying that specifics on foreclosure prevention would emerge in the days and weeks ahead. That didn't reassure markets.
Federal Deposit Insurance Corp. Chairman Sheila Bair is expected to get a bigger role in resolving the mortgage crisis. She favors restructuring troubled mortgages to lower monthly payments and stretching out the loan life to help lenders gain some eventual profit. Lenders have balked at taking losses up front.
Congress is also likely to expand the Hope for Homeowners effort, where lenders are encouraged to take a loss on the original mortgage in exchange for handing it over to the government. While assuming the risk of homeowner default, the government would share in any profits when a homeowner eventually sells.
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