A high-risk rescue

Our view: Proposal to remove toxic bank assets includes many uncertainties

March 24, 2009

Wall Street responded with euphoria when Treasury Secretary Timothy F. Geithner laid out a complex plan Monday to rid banks of as much as $1 trillion in toxic assets and set the stage for a revival of normal lending and a broader economic recovery. The plan is billed as a partnership between the government and private investors, but Uncle Sam would be taking most of the risks and the effort could fizzle if the banks refuse to sell the toxic assets at the prices offered or the pace of lending doesn't pick up.

For those reasons and others, Mr. Geithner's latest proposal carries significant risk at a time of high public anxiety about his management of the nation's economic policy. The plan's success or failure carries large stakes for the nation's recovery, and that's why some political observers are likening it to President Barack Obama's Katrina moment. That's an unfair characterization, but even if the program succeeds, it will only be a first step. Banks will still be holding an estimated $1 trillion or more in bad assets. But the president said he and his economic advisers were "very confident" that the program would start to open clogged credit markets.

Investors who sent the Dow up 500 points yesterday appear to have recognized that Mr. Geithner's program is likely to attract some takers, lured by low risks and potentially high profits. If a pool of bad residential mortgages with a face value of $1 million is auctioned by the Federal Deposit Insurance Corp., a successful bidder might offer $840,000, but all but $120,000 of that amount would be government loans. The private investors' share would be only $60,000, with the other $60,000 a direct investment by the government. If the investment went bad, the government would limit the private investors' losses to 10 percent to 20 percent of what they put up - as little as $12,000.

But many troubled banks may resist giving up at a discount assets that they believe could eventually prove profitable. As tough a challenge for federal regulators will be persuading those same banks to increase their lending.

A course that promises better results would be to have federal regulators simply take over financially troubled banks, sell off their troubled assets, provide them with fresh capital and sell them to new owners. But a president described by some critics as a socialist isn't going to approve a government takeover.

The question that may keep Mr. Obama up at night is what will happen if Mr. Geithner's latest plan fails.

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