U.S. UNVEILS MORE FRUGAL BANK PLAN / THE NEW YORK TIMES

July 9, 2009


U.S. Unveils More Frugal Bank Plan


By GRAHAM BOWLEY and MICHAEL J. de la MERCED


For nearly a year, the question has vexed Washington and Wall Street: What do we do with all these impaired mortgage investments?

The answer still, it seems, is wait and hope.

After months of back-and-forth with the banking industry, the Obama administration on Wednesday unveiled a scaled-down version of its plan to buy troubled mortgage-related securities. The decision represents a huge gamble that banks have recovered sufficiently to help pull the economy out of recession.

In the program, the Treasury, Federal Reserve and the Federal Deposit Insurance Corporation said they would commit up to up to $30 billion of public money to buy bad mortgage-related securities from banks.

They named nine fund managers who together would commit up to an additional $30 billion more and oversee the funds to purchase the assets. The total of $60 billion to go toward purchasing the assets from banks was significantly less than was originally foreseen as being necessary to tackle the ailing financial sector in March.

The Treasury conceded that the program was “modest” but that it could be expanded if the economy or financial markets deteriorated. It also insisted that it was only one of several programs under way to help the economy and that others like the Term Asset-Backed Securities Loan Facility, or TALF, were working well.

The plan was initially started nearly four months ago, as a way to purge banks of trillions of dollars of souring loans and securities built up during the subprime era. The authorities feared these bad assets would weigh down banks and discourage them from making the loans needed to revive the economy.

The decision to scale back the program rests on an assumption that the stabilization of financial markets since then and the return to profitability among some of the banks are sustainable. The risk, some experts warn, is that the worst may not yet be over. Many banks may still face big losses this year and next, particularly if unemployment remains high or, as many economists predict, home foreclosures mount and commercial real estate continues to founder.
“It’s clear that there are a ton of losses still to come,” said Douglas J. Elliott, a fellow of the Brookings Institution. “How prepared are the banks to handle those? There is a great deal of uncertainty here.”

In part, the administration had little choice but to scale back the program. Many banks refused to participate, believing that the assets they hold are worth far more than investors were willing to pay for them. Banks argue that they are in a much better stronger financial position than they were in the spring.
Last month, the administration was forced to postpone indefinitely another central plank of its bank rescue plan — the program to rid the banks of their bad home loans — because it could not persuade enough banks to take part.

Some analysts question whether banks are strong enough to weather further losses.

Although the economy is not deteriorating as fast as it was, unemployment is still rising and banks are still only lending cautiously. The stock market, which reacted ecstatically after the program was announced in the spring, has fallen back in recent weeks, in part because of worries about the sclerotic pace of the recovery.

The Bank for International Settlements warned in its annual report last month that governments worldwide had not done enough to address the issue of weak assets and that this was holding back global lending.

“We will not get out of the recession until we stabilize housing,” said Wilbur L. Ross, one of the fund managers selected. “This is a big step in that direction.”

Some analysts said the authorities were wise to begin with a scaled down version of the program which could be ramped up once it got going and proved to be successful. “I personally think it makes sense to not use all your tools at once,” said Moshe Orenbuch, a bank analyst at Credit Suisse.

Mr. Ohrenbuch said it was not necessarily having troubled assets on their books that was preventing banks from lending again. He cited a range of other factors, including the weakness of demand among businesses and consumers for new loans.

Andrew Rabinowitz, the chief operating officer of Marathon Asset Management, a $9 billion investment firm selected as one of the managers, said that although some of the bigger banks might be reluctant to participate by offloading their assets, there were many other financial institutions that still needed to move bad assets off their books in order to make new loans.

“There’s no question in my mind that there’s a purpose,” Mr. Rabinowitz said.

The prices of impaired assets, which plummeted when the crisis was at its most intense, rallied during the spring, in part because some banks were beginning to hoard the securities in anticipation of the government’s initiatives to help the banks. But prices had fallen back in recent weeks over uncertainty about the scale of the funds and which classes of assets would be included in the program.

Jack Healy contributed reporting.

Copyright 2009 The New York Times Company