Thread: On the way: A bigger, broader bailout: Bailout II.

On the way: A bigger, broader bailout

With up to half of the financial-system aid yet to be spent, the verdict is already in: It won't get the job done. But will another bailout be any better?

By Jim Jubak
MSN Money
Ready or not, here it comes: Bailout II.

With Bailout I, which culminated in then-Treasury Secretary Henry Paulson's now-infamous three-page, $700 billion Troubled Asset Relief Program, clearly unable to stabilize a reeling financial system, new Treasury chief Timothy Geithner has put together Bailout II.

The details await a formal announcement -- quite probably this week -- and the compromises of congressional lawmaking, but the broad scope is clear.

Bailout II will be bigger. It will:

Create a "bad bank" to own the worst of the so-called toxic assets now burning through bank balance sheets.

Guarantee hundreds of billions more in shaky assets that banks decide to keep in their vaults.

Help to prevent foreclosures and to reduce unsustainably large mortgage payments.

Require more limits on CEO pay and bonuses, more visibility into how banks use taxpayer money and more disclosure of who lobbied whom to get billions for specific banks.

The one big thing we won't know, even after the last vote is cast, is whether Bailout II will work. It will embody the best thinking available on how to fix this mess, but this crisis has so far confounded the experts.

Nobody can say the Obama administration hasn't hit the ground running. Even as senators were grilling Geithner in confirmation hearings over why he didn't pay the correct taxes from 2001 to 2004, the administration was laying the groundwork to win congressional and public approval for the new plan.

What? No new jet?
The White House very publicly slapped Citigroup (C, news, msgs) for the company's plan to spend $50 million on a new corporate jet just days after taxpayers ponied up $45 billion to save the bank's behind. Forcing Citigroup to give up its jet scored points with a public that is rightly skeptical about the way that Washington has doled out cash without so much as asking how the banks intended to use it.

The Obama administration should send a thank-you note to John Thain and the folks at Merrill Lynch and Bank of America (BAC, news, msgs) for creating a public fight over the size of the bonuses passed out by Merrill just before it announced a $15 billion loss for the fourth quarter. It's the equivalent of putting a sign that says "kick me" on your back. Politicians haven't been slow to take up the invitation.

In other ways, too, the administration has sought to put distance between Bailout I and Bailout II, even when the latter was no more than a gleam in pundits' eyes. The administration will require the Treasury to keep a log of all meetings and individuals who seek to influence which banks get how much, and it'll post that log on the Internet.

Finally, help for homeowners
But perhaps the most important political move has been the Obama administration's clear call to include relief for homeowners facing foreclosure in Bailout II. The Bush administration had been stubborn in its refusal to include help for stretched homeowners in any bank bailout. That stance faced increasing opposition from Congress and from a public now loudly asking, "Where's my bailout?" By including foreclosure and mortgage payment relief in Bailout II, the Geithner Treasury hopes to get out in front of this issue before it derails any new rescue effort.

So what else is Bailout II likely to include?

A bad bank or banks. This revisits a key concept of Bailout I as first proposed by Paulson -- one that was never enacted even though it was the basis of the plan that Congress thought it had passed. The government would buy up the toxic assets now clogging bank balance sheets and put them on the balance sheet of one big, government-established bad bank (or two).

That would remove one of the major impediments preventing banks from raising private capital: No one wants to put money into a Citigroup because no one knows how many more billions of dollars in losses the bank might face from the toxic assets in its portfolio. No one knows what these assets are worth because the markets that normally value them are either shut down tight by fear or aren't providing prices that anyone believes.

Capital injection rejection
Paulson's Bailout I proposed that the government buy these assets, which was why it was called the Troubled Asset Relief Program. But when push came to shove, the Treasury abandoned the idea in favor of injecting capital directly into banks -- and insurance companies and credit card companies and the financing arms of car companies and . . .

Why the retreat before the idea even got a trial? These assets are so toxic to banks because no one knows what they're worth, so how would the Treasury decide what to pay for them? Pay too much -- 60 cents on the dollar, say, for assets that turn out to be worth just 40 cents -- and taxpayers take a bath. Pay too little -- 20 cents on the dollar for assets that turn out to be worth 40 cents -- and banks get taken to the cleaners.

In any event, bank resistance killed the idea. At that earlier stage in the crisis, banks were still arguing that low prices were just momentary glitches and that assets they couldn't sell today for 40 cents -- and that accountants were forcing them to write down to that level -- would be worth 80 cents someday. The impairment, in accountant-speak, was temporary instead of permanent.

That argument has become less tenable with every passing day as "temporarily impaired" assets have fallen from 40 cents to 30 cents and threaten to go lower rather than rallying back toward 80 cents. Bankers may still regard market pricing for their assets as irrational, but they've been forced to recognize the truth in John Maynard Keynes' aphorism that markets can remain irrational longer than you can remain solvent. In other words, at this point in the crisis, many banks have no choice other than to accept whatever the government sets as a price.

Current thinking at the Treasury is that the government should use financial models rather than current market prices or auctions to determine what these assets are worth. That's exactly what I'd expect from a Treasury still dominated by Goldman Sachs (GS, news, msgs) alums and now headed by a Federal Reserve lifer, and it fills me with trepidation. In short, I don't trust these folks to get me a good deal.

But given the fact that many of these asset markets aren't setting prices at all, I don't think we have any choice. I'd just hope that an Obama administration so comfortable with the Internet would use the Web to post the prices that it's paying. Taxpayers need to see what kinds of deals we're getting.

Why is that important? Because the experience of other countries that have used the bad-bank model for solving a financial crisis -- Sweden is the best example -- says taxpayers can actually come out ahead if the government buys at a good price and hangs on until financial markets recover.

Luring wary investors back to banks
Not all troubled assets would go into a bad bank -- only the worst ones. Less-damaged assets would stay with the banks but get government guarantees.

In other times, before this crisis, banks would have used various derivatives to lay off that risk. (Or at least lay off that risk in theory. As long as everyone agreed that the emperor had clothes, the system worked.) But because it's precisely that derivative market that's shut by fear and precisely those derivatives that make up a good portion of the toxic assets on bank balance sheets, the government has stepped in as the insurer of last resort.

This would turn the ad hoc use of guarantees into a formal program that would gradually, the authors of Bailout II hope, assure the owners of private capital that it's safe to put money into recapitalizing the banks.

(For a scary and very pessimistic view of how badly the banks need capital, see my colleague Jon Markman's column on "Why the bank bailouts are doomed." I agree with much of Jon's data but not with his conclusion, I should note.)

And Bailout II will include a formal commitment to use taxpayer billions to prevent foreclosures by providing subsidies to reduce unsustainable monthly mortgage payments. There's talk that the plan will also include funds to subsidize lenders who write down mortgages that now exceed home values.

Want to buy a bridge in Brooklyn?
None of this is going to be an easy sell. Taxpayers don't think the funds from Bailout I have been handled responsibly, and they're right. They don't think banks have been required to bear as much pain as they should have, given their role in creating this crisis, and they're right. They're outraged that banks that have lost billions and required billions in taxpayer bailouts are paying bonuses, and they should be. If my e-mail is any indication, taxpayers who didn't get in over their heads by buying houses they couldn't afford don't have any sympathy for those people who did, and that's understandable.

Bailout II will address some of this rage. There will be tighter limits on CEO pay and a cap on bonuses, for example. I expect some of any plan to be punitive. Taxpayers and Congress need to see Wall Street and the banks punished before they vote more money for a bailout.

And Bailout II will require more money. The Obama administration has access to the $300 billion to $350 billion from the Troubled Asset Relief Program's original $700 billion that hasn't been spent. But that won't be enough. The Federal Reserve and Treasury believe Bailout II will need to be capitalized at around $1 trillion. The government can get part of the way to closing the gap by leveraging its capital, but my back-of-the-envelope calculations show a need for more taxpayer money.

Will this work? I wish I knew. I think we have to try a plan like this now because it represents our best thinking at the moment for what should work.

One last shot?
But we're at a time that reminds me of scenes in so many science-fiction films in which one of the heroes, having loaded up a space-gun syringe or an experimental missile with the "cure," turns to the other and says, "What if this doesn't work?" The other replies: "It has to work. We've got only this one last shot. The fate of the Earth depends on it."

We've got an edge on those science-fiction heroes. It's only the fate of the financial system and not of the Earth that depends on finding a cure. And if Bailout II fails, the experts will have learned something about how to structure Bailout III.

But it would sure be nice if dumping this truckload of taxpayer money on the banks fixed the problem and we didn't have to contemplate paying for Bailout I and II and III and . . .

The world has got more than one shot at fixing this crisis, but the world doesn't have an infinite supply of capital. Nor do future generations have an infinite capacity to pay back what we borrow today.

http://articles.moneycentral.msn.com/In ... ilout.aspx

One last shot?
But we're at a time that reminds me of scenes in so many science-fiction films in which one of the heroes, having loaded up a space-gun syringe or an experimental missile with the "cure," turns to the other and says, "What if this doesn't work?" The other replies: "It has to work. We've got only this one last shot. The fate of the Earth depends on it."

This reminds me that we are still in the twilight zone with no chance of finding the way out!

Bailout II will also be an illegal alien jobs and benefits giveaway with SCHIP now including illegal aliens who only have to present a stolen social security number to obtain benefits and stimulus and other jobs for them too as employers no longer are required to verify social security numbers, citizenship status and I-9's..........

From what I just heard, Obama met with the Congressional leadership and told them to get the garbage out of the stimulus bill, and telling the Democrats they had to remove some of the garbage so that Republicans can get a word in as to how the money should be spent. I have never heard a president telling his own party to quit the crap, but correct me if am wrong. Obama doesn't seem to put up with garbage, no matter where that garbage came from.