US sets massive bank rescue, stirs worries on Wall Street
Markets find details lacking; Effort could cost trillions
The Obama administration yesterday unveiled a plan to provide up to $2 trillion to shore up the faltering US banking system, but the proposal was not specific enough for Wall Street, where stocks fell sharply.
The Dow Jones industrial average plunged 382 points, or nearly 5 percent, to 7,888.88, its worst day in more than two months. The broader Standard and Poor's 500 index also dived about 5 percent, or 42.73, to 827.16, while the technology-heavy Nasdaq composite index fell 4 percent, or 66.83, to 1,524.73.
The plan, unveiled in Washington by Treasury Secretary Timothy Geithner, continues the $700 billion financial bailout approved during the waning days of the Bush administration. It would combine the remaining portion of that money with up to $1 trillion from the Federal Reserve and aims to use federal investment to attract billions more from private investors.
Geithner promised strict oversight of taxpayer money while pledging to direct funds to help struggling homeowners avoid foreclosure. "The battle for economic recovery must be fought on two fronts," he said. "We have to both jump-start job creation and private investment, and we must get credit flowing again to businesses and families."
Markets opened lower yesterday over skepticism about the Obama plan, and the sell-off accelerated after Geithner failed to provide many details of how key components of the bank rescue would work. For example, the Obama plan calls for a partnership between the federal government and private investors to buy mortgage-backed securities and other so-called toxic assets that are undermining banks' financial positions. But it provided few details of how this partnership would be structured, how it would attract private capital, or how assets would be bought.
"It's like getting a beautifully wrapped present that you open and find out it's an empty box inside," said Diane Swonk, chief economist at Mesirow Financial, a Chicago financial services firm. "There was so much build-up, but it's still a skeleton of a plan."
Barney Frank, the Newton Democrat who chairs the House Financial Services Committee, called Geithner's revised plan "clearly a very substantial improvement over the Bush approach."
But the lack of specifics, analysts said, fed investor worries that the plan could take too long to implement when quick action is needed to shore up a rapidly deteriorating banking system. Without healthy banks, the credit that fuels consumer spending and business expansion can slow to a trickle, undermining the economy as consumers stop buying and businesses cut jobs.
The collapse of the banking system in the 1930s is blamed by economic historians, including Federal Reserve chairman Ben Bernanke, for transforming an average recession into the Great Depression.
"Putting this in place is going to take time, and the platform is burning," said Brian Bethune, chief US financial economist at IHS Global Insight in Lexington. "This proposal is too fuzzy, and there's not a sense this Treasury knows what the critical issues are for the financial system."
The banking bailout is part of a two-pronged attack by the Obama administration to stop the downward spiral that has seen the economy shed nearly 2 million jobs over the past three months, including some 600,000 in January. The other component, an approximately $800 billion stimulus package of spending and tax cuts, was approved the Senate yesterday.
The Senate and the House, each of which has approved a different version of the stimulus package, must now work out the differences to craft a compromise bill. President Obama has called for a final bill by early next week.
Obama's plan to revive credit would continue the Bush administration's practice of injecting capital directly into banks in exchange for ownership stakes. It would also include an element that was scrapped by the Bush administration: buying mortgage-backed securities and other assets backed by consumer and business loans, including credit cards and auto loans.
These assets are considered toxic because banks can't sell them to investors, who worry the loans backing the assets will default. As the economy and housing market worsen, the value of the these assets declines, creating losses for banks and leaving them with less to lend.
The Obama plan would use public money to attract private investors, and use its borrowing power to raise up to $1 trillion to buy these assets. Geithner did not specify what the initial public investment would be and provided few details about the plan. Cornelius Hurley, who teaches banking law at Boston University, called Geithner's remarks "a good plan, poorly articulated" because so much is unclear.
Any program to remove those assets would be good news, even if values fall so low that selling those assets would cause some banks to fail, Hurley said. "If the net result of buying these assets is that you wash out many banks, then people are prepared to deal with that," he said. "It's the uncertainty that's driving people nuts."
The plan also calls for strict oversight of banks that take government money, requiring that they increase lending. It also restricts the dividends to 1 cent per share until the government is repaid, and limits top executive salaries to $500,000 plus restricted stock options.
The Federal Reserve, working with the Treasury Department, will also expand its programs to keep credit flowing. The Fed said it would lend up to $1 trillion to banks and take highly-rated securities backed by consumer and small business loans as collateral.
The Obama administration would also devote about $50 billion to help prevent foreclosures.
Frank said he would support a moratorium on foreclosures once money is dedicated to helping struggling homeowners to keep their residences. It would make no sense to allow a family to be forced from a home when assistance could be available in a few weeks.
"Now the time has come for a foreclosure moratorium," Frank said.
Robert Gavin can be reached at rgavin@globe.com.; Ross Kerber at kerber@globe.com. 