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Feb 10, 2009

Wall Street rescue: $2.3 trillion - the cost of US bank bailout

President Barack Obama's administration placed an eye-watering $2.3 trillion price tag on its plan to bail out the US banking system yesterday, opening up what it called a second front in the battle to pull the country out of recession.

As the $800bn economic stimulus plan finally passed the Senate, attention began shifting to the even bigger problem of fixing a financial system that has been on government life support since September.

Tim Geithner, the US Treasury secretary, said expansion of the unpopular Wall Street bailout plan is necessary because the government has for too long been "behind the curve, always chasing the escalating crisis". But expansion of the scheme, first launched by George Bush, threatens to unleash new political controversy. Critics say the new plan is short on detail, leaving some of the most important and vexing issues unresolved.

Mr Geithner called the expansion "comprehensive and forceful", but stock markets tumbled as investors derided the lack of detail.

The administration has pledged the revised financial stability plan will come with tough rules on what banks can do with government money.

This comes in response to public fury over continuing bonuses and perks being enjoyed on Wall Street, despite some $350bn of government money already having been given to ailing institutions. Under the new plan, instead of diverting cash into shareholder dividends or acquisitions, each bank will have to lend the fresh money to small businesses and consumers, who are bearing the brunt of the credit crunch.

There will be much more transparency, too, Mr Geithner promised. "Our challenge is much greater today because the American people have lost faith in the leaders of our financial institutions, and are sceptical that their government has used taxpayers' money in ways that will benefit them," he said. But he echoed Mr Obama's warning during Monday's televised press conference that rescuing the banking system is central to restoring health to the US economy: "Instead of catalysing recovery, the financial system is working against recovery," said the Treasury Secretary. "The battle for recovery must be fought on two fronts. We have to both jumpstart job creation and private investment, and we must get credit flowing again to businesses and families."

The new plan aims to balance aid for Wall Street with support, too, for main street. In particular, there will be $50bn set aside to bring down mortgage payments for borrowers struggling to avoid foreclosure. However, the bulk of assistance will be targeted at banks, which will undergo a "stress test" to see if they need government funds. And there will be a $1trn "public-private investment fund" that will buy toxic assets from the banks, finally freeing them up to start lending again. However, despite stoking anticipation on Wall Street, Mr Geithner said only that he was "examining a range of different structures" – comments which sent the US stock market down almost 4 per cent.

In addition, there will be extraordinary new efforts to get the credit markets moving, even without the help of moribund banks. The Federal Reserve will flood the system with $1trn in new loans to investors who want to help finance business and consumer lending.

Mr Obama used his televised press conference on Monday night to pile still more pressure on Congress to pass his economic stimulus plan, which aims to create jobs through about $800bn in Government spending and tax cuts. Yesterday he went to Fort Myers in Florida, where the jobless total has tripled in two years, to telegraph back to Washington the pain being felt in parts of the country. "We can't afford to posture and bicker," he said. Senate Democrats passed an $838bn stimulus bill with the help of three Republicans, but its menu of tax and spending measures differs significantly from a Democrats-only plan passed by the House of Representatives last month. Marrying the two could be politically volatile, although the White House says it still expects a final compromise plan to reach the President by 16 February.

In contrast to the stimulus bill, the new Wall Street rescue plan unveiled yesterday is not likely to require significant legislation by Congress. Later, Mr Geithner warned Congress it might have to approve significant additional funds on top of the original bill.

Last October, it voted to allocate $700bn to bail out the banks, half of which has been spent. The government money eventually spent on the new plan will be significantly less the $2.3trn headline cost, because much of the money is only being loaned, and the assets purchased might turn a profit. While working on the details of the latest rescue, Mr Geithner said that he would step up efforts to reach international agreements that could prevent a similar crisis. Finance ministers from the G20 industrialised nations will meet in Italy this weekend and discuss regulatory reform.

Obama's proposals

Reduce home repossessions: $50bn

Why is this important?

The giant hole at the centre of the banking system opened when US house prices began to fall, wiping trillions of dollars from the value of collateral held by banks – and it is widening still. As repossessed homes flood the market, it remains in freefall and is causing untold human misery.

What is the plan?

To encourage mortgage lenders to lower repayments or even the size of the debt. There will be a variety of incentives for lenders, including government compensation and possibly protection from lawsuits filed by investors.

Unanswered questions

The details will be announced in the next few weeks. It is unclear whether the sums involved will be enough to make a real dent in the rate of foreclosures, and reducing the supply of repossessed homes is only part of the problem. As the recession gathers pace, demand from nervous buyers has also slumped.

More money for banks: $300bn

Why is this important?

Until the giant hole at the centre of the financial system is plugged, the banks' lending activity will remain at a sluggish pace, and that means businesses, homeowners, car buyers, college students and property developers will continue to have trouble finding loans. Those loans are the life-blood of economic activity, and their absence is compounding the recession.

What is the plan?

Major banks will face a "stress test" to judge how much capital they need, not just to stay solvent through the recession but to increase their lending again. If banks need taxpayers' money, they will have to pay punitive interest rates, give the Government a stake in their company and accept transparency rules to shame them into cutting executive pay and perks.

Unanswered questions

All depends on the assumptions that go into the "stress test". If the economy worsens, the administration may need to ask Congress for more than the $300bn that remains in the kitty. The government could end up effectively owning the biggest banks in the US, and private investors are unlikely to advance their own capital to banks under those circumstances.

Dealing with toxic loans: $500bn to $1trn

Why is this important?

Banks are still sitting on trillions of dollars of soured mortgage investments and other bad loans, whose value depends entirely on how bad the economy gets. Because there is no clarity, there is paralysis. Banks have wrestled for more than a year with ways to rid themselves of these toxic assets.

What is the plan?

Using tax dollars, loans from the Federal Reserve and private money, the Treasury plans a "public-private investment fund" to buy toxic assets. It will grow over time and use expertise from private companies to set a value for the assets.

Unanswered questions

There is still no answer to the pivotal question of how much to pay banks for their toxic assets. If the price is low, several lenders could be forced to write down the value of their assets to a point that makes them insolvent. But private investors hardly want to pay over the odds – and neither should taxpayers.

Kick-start credit markets: $1trn

Why is this important?

The loans that businesses and consumers rely on do not all come from the banking system. About 40 per cent are financed by hedge funds and other investors, who buy parcels of these loans in the secondary market. That market has all but dried up, which is making loans even harder to come by.

What is the plan?

The US Treasury and Federal Reserve already have a $200bn lending programme aimed at kick-starting these markets, but this will be vastly increased in size. Investors will be lent money to buy parcels of credit card loans, student and small business loans, and now commercial mortgages as well, to prevent a collapse in the property market.

Unanswered questions

The appetite of worried investors for re-entering the embattled American credit markets is still to be tested, because the existing programme is still in its infancy. No matter how much financing becomes is available, there could be resistance to making new loans if the US economy is still heading downwards.

Source : Independent
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