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.
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.”
Geithner said last week the administration was reviewing the option of setting up a bad bank, but that it is “enormously complicated to get right.”
Nonperforming loans on U.S. banks’ balance sheets are seen as a key reason why banks are reluctant to resume lending.
The lack of credit has contributed to a year-long recession sparked by the collapse of the housing market.
A series of government efforts to clean up the mess have fallen short, as evidenced by banks such as Citigroup and Bank of America Corp (BAC.N) coming back to the government for more money in return for partial public ownership.
Goldman Sachs economist Jan Hatzius has estimated total credit losses may exceed $2 trillion globally, and banks have so far recognized less than half that much.
A senior International Monetary Fund official said Wednesday that bank balance sheets must be cleansed to revive lending, but it will be hard to put a value on the bad assets.
“It is more easier said that done, that’s for sure,” said Jaime Caruana, head of the IMF’s financial and capital markets division.
Douglas Elmendorf, the new head of the Congressional Budget Office, said Wednesday that a “bad bank” plan would be fraught with challenges as policymakers try to pay the right price.
“Pricing should give financial institutions an incentive to solve their problems on their own if they are in a position to do so, and should mean shuttering institutions that have little prospect of recovery,” he told the Senate Budget Committee.
At a Citigroup conference in New York, KeyCorp (KEY.N) Chief Executive Henry Meyer said the Cleveland-based regional bank would consider moving some assets to a bad bank as long as the assets were assigned fair rather than “low-ball” values.
U.S. lawmakers have yet to see details of how a bad bank option would be carried out, indicating the White House is still formulating its plan and working out the details.
At the Financial Services Forum, Dearie said other issues include how a bad bank would be financed, who would run it, and what the ripple effects would be on banking. “The devil is in the details,” Dearie said.
Additional reporting by Rachelle Younglai, Stella Dawson, Patrick Rucker, and Glenn Somerville in Washington, D.C., and Jonathan Stempel and Dan Wilchins in New York; editing by Steve Orlofsky, Tim Dobbyn and Jeffrey Benkoe