Treasury Hashing Out Plan; Grants Access to Insurers

The current plan is expected to be smaller than previously expected in that it will be paid for out of the remaining money in the original TARP plan, which is about $350 billion. Some of that money, however, will remain earmarked for home foreclosure relief.

The size of the problem is far bigger than that. Experts estimate there are some $1.5 trillion to $2 trillion in such bad assets, either of the non-performing or illiquid variety.

The ring-fence concept, which is part of what's being discussed, has already been used with Citigroup   and Bank of America . It involves government guarantees and insurance provisions for groups of bad assets, but they remain on the balance sheet of the institution. The bad bank concept literally removes them. Both approaches are meant to spur new lending by banks.

Thus far, the bulk of the government's aid under the TARP program has been through a capital-for-equity swap. The so-called capital injection method was adopted at the urging of Congress late last September and then wound up replacing Paulson's original, primary tool of a government auction to buy the troubled assets.

The capital injection program is expected to be revised such that the government receives convertible preferred stock, instead of the current preferred stock. New limits on executive pay were imposed earlier this week.

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The former include an option to be converted, usually any time after a predetermined date, into an amount of common stock, which is how some would now like to see the government take its equity stake.

Rep. Brad Sherman (D.-Calif.)—a senior member of the House Financial Services Committee who voted against the original TARP and favors the capital injection model—is concerned that the ring fence concept might include a multiplier approach in backing troubled assets, rather than a virtual dollar-for-dollar approach.

"And the question is: will the Fed participate," asks Sherman. If so, he says, it would clearly give the government more money to work with.

Political Factors

The latest developments come as Congressional support for the bad bank concept and additional financial support for the banking sector has faded.

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

House Speaker Nancy Pelosi (D.-Calif.) Wednesday said she was "not so sure" that another bailout request from the Obama administration is inevitable, reversing an a previously-held assumption.

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Congressional Democrats, led by House Financial Services Committee Chairman Barney Frank (D.-Mass.) have told the new administration that they are angry and disappointed that former Treasury Secretary Henry Paulson’s administration of the TARP program was both too generous to and too lenient on Wall Street firms.

They've also made it clear that they want significant government funding to aid consumer borrowers, small business and the housing industry, as well as tighter rules on executive pay for firms participating in the TARP. President Obama unveiled those rules Wednesday.

Geithner met with House Democrats Saturday, according to Reuters told them firms receiving aid would have to make mortgage loan modifications.

Citigroup has already agreed to such terms in receiving what the government calls "exceptional" aid.

Tougher terms on lending have significant support among House Democrats, but even some proponents say they wind up being somewhat toothless.

The source said the Obama administration is keenly aware of the political dynamic and is thus proceeding at a cautious pace, knowing it will need support all along the way if it is to seek new funding authority requiring Congressional approval.

The timing of the announcement on Monday speaks to that issue. Starting Tuesday, Geithner will brief the respective houses of Congress on a variety of new measures meant to ease the credit crunch.

- CNBC Senior Economics Reporter Steve Liesman contributed to this report.

© 2012 CNBC.com

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