Obama Officials Struggle Over 'Bad Bank' Plan

The Obama administration is still struggling with the details of a bad bank concept that is expected to be part of a package of industry and consumer measures to be unveiled next week, according to a source familiar with the situation.

What’s likely to be unveiled Wednesday on executive compensation limits, may not be as tough as expected, according to an industry source, who played down its impact.

“They’re still trying to solve the bad bank [pricing] thing,” an industry source said. “It’s not ready for prime time.”

When asked if that could lead to a delay in next week’s announcement, the source said, “Anything they roll out would seem hollow without a bad bank concept.”

Representatives of the Obama administration and the financial services industry capped three days of talks on the bad bank idea and other measures to ease the credit crunch Sunday, following speculation Friday that the pricing issue had become a major hurdle.

Another source—this one on Capitol Hill—didn’t believe a decision had been made as of Tuesday.

• TARP Executive Pay Limits to Be Set at $500,000

The bad bank concept—namely a government entity to buy, hold and eventually sell bad, or toxic assets, from financial firms to help clean up their balances sheets and spur new lending—has attracted growing support since Federal Reserve Chairman Ben Bernanke proposed it in a major speech three weeks ago.

Nevertheless, it has been dogged by debate and doubt over how to price the assets, which some estimate could total $1.5 trillion to $2 trillion and which fall into two broad categories—non-performing and illiquid.

Like with former Treasury Secretary Henry Paulson’s plan for an auction process to absorb the assets, the big challenge has been how to find a happy median between what the government is willing to pay and what firms are prepared to sell for, especially given the assets’ depressed value in the current market.

The bad bank concept is one of several options under consideration by the Obama administration. Apparently, there is currently sufficient support to continue the previous administration’s capital-for-equity plan, as well as the recently implemented “ring fence" concept.

Somewhat similar to the bad bank concept, it involves government guarantees and insurance on troubled assets which stay on the firm’s book. The Fed and FDIC recently used such as approach with Citigroup and Bank of America . Similar to the bad bank concept, it involves government guarantees and insurance on troubled assets which stay on the firm’s books. The bad bank concpet actually removes the assets from the institution's books. Both measures are meant to clean up firms' balance sheets and spur new lending.

It’s also unclear how much support the bad bank concept—and indeed more aid to financial firms in general—has among Democrats in Congress, where the party holds sizable majorities.

Sen. Charles Schumer (D-NY), a senior member of the Senate Banking Committee, Tuesday joined the skeptics, telling CNBC the bad bank approach would be "hugely expensive" and added he prefers government guarantees of such assets.

Rep. Brad Sherman (D.Calif.), a ranking member of the House Financial Services Committee who opposed the original TARP plan, is adamantly opposed to anything but capital injections, which he says give the government its best potential return on investment through preferred stock and warrants.

“I’m trying to get people to say we don’t buy toxic assets, we buy preferred stock," said Sherman. “With the ring fence or bad bank you know what you’re paying but would anyone know the value of what you are receiving?” Sherman has made his position known to Treasury Secretary Timothy Geithner.

Though the Obama administration does not need Congressional approval to use the remaining $350 billion of the original $700 billion in TARP approved last fall, sources on Capitol Hill say it will probably want to get their support in principle in the event new appropriations are needed to fund future government aid efforts. There’s already growing talk of a so-called TARP 2 or 3.

• Slideshow: Bank Failures of 2008

And that’s one reason why the issues of executive compensation and lending practices for firms taking part in the aid program are so intertwined with the advancement of new initiatives.

Congressional Democrats had made it clear to the new administration that they want significant government funding to aid consumer borrowers, small business and the housing industry, following their anger and disappointment over Paulson’s administration of the TARP program, which was seen as too generous to and too lenient on Wall Street firms.

CONTINUED : How Will Next TARP Installment Unclog Lending?

---

1 | 2 | Next >