FDIC May Run ‘Bad Bank’ in Plan to Purge Toxic Assets (Update2)

Jan. 28 (Bloomberg) -- The Federal Deposit Insurance Corp. may manage the so-called bad bank that the Obama administration is likely to set up as it tries to break the back of the credit crisis, two people familiar with the matter said.

U.S. stocks gained, extending a global rally, on optimism the bad-bank plan will help shore up the economy. The Standard & Poor’s 500 Stock Index rose 1.9 percent to 861.63 as of 9:54 a.m. in New York. Bank of America Corp., down 54 percent this year before today, rose 87 cents, or 13 percent, to $7.37. Citigroup Inc., which had fallen 47 percent this year, climbed 18 percent.

FDIC Chairman Sheila Bair is pushing to run the operation, which would buy the toxic assets clogging banks’ balance sheets, one of the people said. Bair is arguing that her agency has expertise and could help finance the effort by issuing bonds guaranteed by the FDIC, a second person said. President Barack Obama’s team may announce the outlines of its financial-rescue plan as early as next week, an administration official said.

“It doesn’t make sense to give the authority to anybody else but the FDIC,” said John Douglas, a former general counsel at the agency who now is a partner in Atlanta at the law firm Paul, Hastings, Janofsky & Walker. “That’s what the FDIC does, it takes bad assets out of banks and manages and sells them.”

Bank Management

The bad-bank initiative may allow the government to rewrite some of the mortgages that underpin banks’ bad debt, in the hopes of stemming a crisis that has stripped more than 1.3 million Americans of their homes. Some lenders may be taken over by regulators and some management teams could be ousted as the government seeks to provide a shield to taxpayers.

Bank seizures are “going to happen,” Senator Bob Corker, a Tennessee Republican, said in an interview after a meeting between Obama and Republican lawmakers in Washington yesterday. “I know it. They know it. The banks know it.”

Laura Tyson, an adviser to Obama during his campaign, said banks need to be recapitalized “with different management” so they start lending again. “You find some new sophisticated management unlike the failed management of the past,” Tyson, a University of California, Berkeley, professor, said at the World Economic Forum conference in Davos, Switzerland today.

Still, nationalization of a swath of the banking industry is unlikely. House Financial Services Chairman Barney Frank said yesterday “the government should not take over all the banks.” Bair said earlier this month she would be “very surprised if that happened.”

TARP Size

Obama is under increasing pressure to drastically revamp the $700 billion Troubled Asset Relief Program for the ailing industry. While setting up a bank to buy underwater assets is emerging as a favored approach, it could drive up the cost of the rescue in excess of $1 trillion.

Frank told reporters that he would be open to expanding the size of the bailout if the Obama administration “can demonstrate the need for it.”

Senate Banking Committee Chairman Christopher Dodd said yesterday he wants to hear more about the bad-bank idea when he meets in coming days with newly installed Treasury Secretary Timothy Geithner.

Geithner, who was sworn in earlier this week, has pledged to unveil a “comprehensive plan” for responding to the crisis that will aid financial companies as well as small businesses, cities unable to borrow money and families facing home foreclosure.

Obama Meeting

The new administration is also pressing Congress to pass an $825 billion economic stimulus, which could complicate any effort to get additional bailout funds from lawmakers. Obama will today meet with chief executive officers at the White House on the stimulus. The White House declined to release the names of the CEOs.

A key question for the bad bank would be how to value the toxic assets it would buy. Geithner, in a Jan. 21 hearing before the Senate Finance Committee, outlined three possible alternatives: look at how the market is pricing similar assets; use computer model-based estimates from independent firms; and seek the judgment of bank supervisors.

“They all have limitations,” he said. “I think you need to look at a mix of those types of measures.”

Federal Reserve Chairman Ben S. Bernanke suggested on Sept. 23, when then Treasury Secretary Henry Paulson was initially considering buying bad assets, that the government should purchase them at values above the near fire-sale prices prevailing in the market.

Issuing Stock

Bair has said that cash from the TARP may help capitalize the bad bank and that commercial lenders may kick in some money of their own. One possibility that’s been discussed is issuing firms some kind of stock in the new organization as partial payment for their impaired assets.

FDIC spokesman Andrew Gray declined to comment.

In any new rescue efforts, the Treasury is likely to continue to require banks to hand over ownership stakes to the government as a condition of receiving aid. Programs so far have sought preferred shares and warrants, which can be converted into common stock and cashed out on the government’s request.

Bernanke, who has endorsed the idea of a bad bank, is discussing fresh strategies for combating the financial crisis with his central bank colleagues this week. The Fed’s Open Market Committee today will release a statement about 2:15 p.m. in Washington.

Insuring Assets

The Fed has participated in Treasury-led initiatives that insured toxic assets remaining on the balance sheets of Citigroup and Bank of America, and analysts said such measures could be used to complement the bad bank.

The government will likely use its ownership of toxic assets to rework soured mortgages and prevent foreclosures.

The FDIC is already modifying troubled mortgages held by IndyMac Federal Bank FSB, the successor to the failed lender managed by the agency since July. Bair, a longtime advocate of foreclosure relief, said the initiative was meant to serve as a model for the mortgage industry.

The Fed also said in a policy paper released yesterday by the House Financial Services Committee that it will ease terms on residential mortgages acquired in the rescues of Bear Stearns Cos. and insurer American International Group Inc.