"Bad bank" idea heats up, financial shares soar

By Karey Wutkowski and John Poirier

WASHINGTON (Reuters) - The Obama administration is increasingly focused on the possible creation of a "bad bank" that would let U.S. financial institutions move toxic assets off their books, an idea that cheered Wall Street and helped drive financial shares higher on Wednesday.

Richard Parsons, who spoke with U.S. President Barack Obama earlier Wednesday, said at a conference in New York that Obama is looking at an "aggregator" bank. Parsons said such a bank could potentially take trillions of dollars of assets off banks' balance sheets.

Obama is also thinking about how to fix the economy more broadly, Parsons said. The economy faces "a death spiral, and it only gets worse if there's no intervention," he added. Parsons, the incoming chairman of Citigroup Inc (C.N), said he was speaking as a private individual, not on behalf of Citigroup or any other entity.

Sheila Bair, chairman of the Federal Deposit Insurance Corp, has floated the idea that her agency should manage such a bad bank, two industry sources told Reuters.

Bair contends the FDIC is best positioned to run such a government entity because it has years of experience disposing of the least valuable assets of failed banks, according to one of the sources, who has direct knowledge of Bair's thinking.

An FDIC spokesman declined to comment directly, but said the agency continues to provide its "best thinking on potential policy decisions" to the White House and Treasury Department.

"Sheila Bair seems to be offering her agency as a logical manager of this plan because it is the FDIC's traditional role and it is their expertise," said John Dearie, executive vice president at the Financial Services Forum, who previously held roles at the New York Federal Reserve.

Financial stocks traded higher on optimism that Obama will swiftly act to stabilize the ailing banking sector. The Standard & Poor's index of financial stocks .GSPF rose 13 percent.

"Any sort of credible plan for dealing in a definitive way with these toxic assets is music to the ears of equity investors," Dearie said.

Laura Tyson, an economic adviser during Obama's election campaign, fueled speculation Wednesday that creation of a bad bank was near. She said repairing financial markets and revitalizing lending will require governments to remove bad assets from banks and recapitalize them.

"The natural next step is, which is real simple, you take the bad assets out, the balance sheets are hit really hard, you recapitalize banks with different rules, and they go out again and lend," Tyson said in a panel discussion at the annual meeting of the World Economic Forum in Davos, Switzerland.

DISCUSSING FOR WEEKS

For weeks, top U.S. policymakers have been discussing the idea of a bad bank, also known as an aggregator bank.

The Obama administration had hoped to reveal a comprehensive plan by the end of this week to stabilize the financial system, according to industry sources. The timeline is still fluid, they said.

U.S. Treasury Secretary Timothy Geithner said Wednesday the administration is "looking at a range of options" to repair the financial system, and decisions could be made public "relatively soon."