UPDATE 2-US officials mull establishing "aggregator bank"

WASHINGTON, Jan 16 (Reuters) - Top U.S. policy-makers said on Friday they are discussing setting up a government bank that would use federal funds to buy troubled assets from financial institutions to try to stem a virulent financial crisis.

Outgoing U.S. Treasury Secretary Henry Paulson and Federal Deposit Insurance Corp Chairman Sheila Bair both said an “aggregator bank” was one of several ideas U.S. regulators had been discussing.

An Obama spokesman was not immediately available to comment.

On Tuesday, Federal Reserve Chairman Ben Bernanke and the central bank’s No. 2 official, Donald Kohn, both said setting up so-called bad banks to take distressed assets off the books of struggling institutions were among options to consider.

Bair told CNBC television the idea would be to use the government’s $700 billion financial rescue fund to capitalize an “aggregator bank.”

“We think by leveraging (Troubled Asset Relief Program) funds in this way, we could have significant capacity to buy troubled assets,” she said.

Paulson, who departs office when the new administration takes over on Tuesday, said an “aggregator bank” was one of a number of ideas that have been under discussion.

“There have been a variety of ideas that we have worked on here,” he told reporters. “There’s a lot of work that’s been done on an aggregator bank, other ways of leveraging TARP funding to let it go further when it comes to dealing with ill-liquid assets.

Paulson said another idea would be to have the Fed expand a program currently aimed at supporting consumer credit by using financial rescue funds to cover credit risk and allow the Fed to extend its support to riskier assets, such a commercial mortgage-backed securities.

Bair said the FDIC, U.S. Treasury Department and Fed have also discussed leaving troubled assets on banks' balance sheets, but giving them some sort of government insurance wrap, similar to the approach used for the Bank of America BAC.N deal announced earlier on Friday. This idea was also broached by Bernanke on Tuesday.

Bank of America is receiving a federal backstop against $118 billion of bad assets it holds, as well as $20 billion in fresh government capital, as part of an aid package designed to help it absorb Merrill Lynch & Co.

“We’ll support any approach that we think is effective,” said Bair, who is expected to stay on as head of the FDIC after President-elect Barack Obama takes office on Tuesday.

The U.S. Treasury has already committed more than half of the $700 billion fund, and a vote by the Senate on Thursday cleared the way for the final $350 billion in funds to flow.

Bair said an “aggregator bank” would be capitalized by the second half of the $700 billion TARP fund. She said it would be similar to the Resolution Trust Corp, which liquidated almost $400 billion in assets from more than 700 insolvent savings and loans from 1989 to 1995.

The top bank regulator also said the government could require that banks also raise a portion of private equity if they want to sell troubled assets to the aggregator bank.

“People on the street tell me that private equity investment is holding back now because they don’t know what the tail risk is,” she said.

Paulson said he believed a substantial portion of the second half of TARP funds should be used to help shore up bank capital. With their balance sheets clogged by nonperforming assets, banks have been struggling to raise private funds.

Bair said she is unsure whether the government will continue to have to step in to boost financial firms’ capital levels.

“I hope that further capital injections will not be necessary, but I will not rule out the possibility that they will be needed,” she said.

She also said the Obama administration is working very hard on a home foreclosure prevention efforts that would use a “significant portion” of TARP funds.

“I think they’re committed to getting something up and running very quickly,” Bair said. (Writing by Karey Wutkowski and Tim Ahmann)