Bailout: Getting Banks to Bite

As the Obama Administration's plans to lift toxic assets off bank balance sheets took form, speculation swirled over whether private-sector investors could be enticed to take part. Now another question is looming: Will the banks participate?

On Mar. 23, Treasury Secretary Timothy Geithner unveiled the latest effort by the government to stabilize banks and unlock frozen credit markets. The long-awaited plan would use $75 billion to $100 billion of federal bailout funds—together with an equal amount of private-sector money and federal loans and guarantees that could bring the total investment to $1 trillion over time—to buy questionable, mostly mortgage-backed assets from banks.

The market soared in response, with the Dow Jones industrial average rising nearly 500 points, or 6.8%. The financial industry hailed the plan as a solid fix that could revive a moribund credit market. But while that reaction relieved some of the immediate pressures on Geithner and the Administration, it was hardly unanimous. Critics called it a series of opaque subsidies that, at best, would prop up the banks and their shareholders without doing much to revive lending. And the embattled Treasury secretary clearly knows he faces huge challenges ahead. "One day's [market] reaction does not make a plan," he said, speaking later that evening at a conference on the future of finance sponsored by The Wall Street Journal.

Funds Leveraged Sixfold
In many ways, the plan is straightforward: Private-sector investors will bid to buy a stake in pools of assets—either residential and commercial mortgage loans, or securities tied to a variety of other troubled debt—and their investments will be matched dollar for dollar by the Treasury. Those funds will then be leveraged as much as sixfold through loans backed by either the Federal Deposit Insurance Corp. or the Federal Reserve.

But the same dynamic that has stymied the normal market for these securities could discourage banks from participating, investors and financial experts say.

At the root of it, banks and investors disagree about what the assets are worth. Investors point to the dramatic collapse of the housing market and rising foreclosure rates, among other factors, that mean many of the assets are unlikely to perform as advertised, particularly as a worsening economy puts further pressure on the underlying borrowers.

Banks on Shaky Ground
Banks note that 90% or more of homeowners are current on their mortgages. They argue that most of the assets will ultimately perform—and thus are worth far more than the discounted prices investors are willing to pay. Moreover, many banks are already on shaky financial ground, and recognizing the assets at a lower value could leave them worse off, and potentially insolvent.

But while the program announced Mar. 23 contains sweeteners to entice investors to the table—chief among them government-backed financing—banks may remain reluctant to sell unless the ultimate price matches or exceeds the asset value the banks have recorded on their books. And Sheila Bair, chairman of the FDIC, made clear later in the day that she expects banks to take a hit: "They will have to take losses to sell into this facility," she said.

In that case, warned one bank analyst who works for an investment management company, "there's no incentive for banks to participate."