The plan will be "smaller" than originally expected, said the industry source, and centered around government guarantees and insurance of troubled assets—what's called a "ring fence" concept.
"Everybody seems to like that," said the source. "There's a lot of internal conflict about whether this [the bad bank] makes sense ... they realize they have to do something with the bad bank."
Progress On Pricing Issue
The latest round of discussions also appears to have addressed the most controversial aspect of the big bank concept: pricing.
Under the emerging plan, the government will buy toxic assets below the banks' "carrying value," which is basically market value, but not at fire-sale levels, the source said.
Such a pricing approach will likely placate both taxpayer and Congressional concerns about the government over-paying for the assets. But, the source noted, it could "trigger an accounting problem for the banks," presumably because the institutions will have to report a loss on the transactions.
The Obama administration is now working on ideas to address that, which might entail a temporary suspension of certain accounting rules. It is unclear what that might be, said the source.
Financial stocks moved higher Thursday on speculation that the government may temporarily suspend the mark-to-market accounting rule, which has been advocated by some on Wall Street and in Washington. Former FDIC Chairman William Isaac, for instance, has urged that it be dropped altogether.
Senate Banking Chairman Christopher Dodd (D-Conn.) told Reuters Wednesday evening that it might be possible to modify the mark-to-market rule without abandoning the underlying concept, as the news service put it.
The Securities and Exchange Commission and the Financial Accounting Standards Board set those rules. The SEC Thursday declined comment.
The FASB, which happened to holding a routine meeting of its valuation advisory committee Thursday, also declined comment.
The current plan is expected to be smaller that 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-$2 trillion in such bad assets, either of the non-performing or illiquid variety.
The ring fence concept has already been used withCitigroup andBank 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, however, is not expected to be a major part of the new aid package, according to the source. It will also be tweaked, apparently, so that the government receives convertible preferred stock, instead of the current preferred stock.
The former include an option to be converted, usually any time after a predetermined date, into a amount of common stock, which is how some would now like to see the government take its equity stake.
Regardless of the merits of one measure or another, there's growing consensus in both government and banking that a one-size-fits-all approach is inappropriate. JPMorgan Chase CEO Jamie Dimon, for one, has made that point recently.
Rep. Brad Sherman (D.-Calif.), who voted against the original TARP and favors the capital injection model, now expects any forthcoming plan to include such asset purchases, as well as the ring fence concept and the purchase of toxic assets.
"It's consistent with their view of trying new things," says Sherman, a senior member of the House Financial Services Committee.
One of his concerns about the ring fence approach is to what extent the administration might use a multiplier method 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.
The latest developments come as Congressional support for the bad bank concept and additional financial support for the banking sector are fading.
Sen. Charles Schumer (D-NY), asenior 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.
In a news conference Wednesday afternoon, House Speaker Nancy Pelosi (D.-Calif.) said she was "not so sure" that another bailout request from the Obama administration is inevitable, reversing an a previously-held assumption.
Congressional Democrats, led by House Financial Services Committee Chairman Barney Frank (D.-Mass.) have shared with the new administration their anger and disappointment over former Treasury Secretary Henry Paulson’s administration of the TARP program, which was seen as 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.
Frank Wednesday announced that the committee will hold a hearing on firms' use of TARP money to date and will call on eight big-name CEOs to testify. They include Ken Lewis (BofA), Vikram Pandit (Citigroup), Dimon, (JPMorgan Chase), John Mack (Morgan Stanley) and Lloyd Blankfein (Goldman Sachs ).
The source said the Obama administration is keenly aware of the political dynamic and is thus proceeding at a cautious pace. Some in Congress agree.
"I think they've talked to the political leadership," says Rep Sherman. "Everything they're doing with the second $350 billion [of the TARP] is with an eye to asking for a third $350 billion and we'll be lucky if it is only $350 billion."
Details are expected to be announced Monday. Treasury Secretary Tim Geithner next week will brief the respective houses of Congress on a variety of new measures meant to ease the credit crunch.