Government hopes bank aid helps recession recovery

— -- The federal government is about to mount what could be the largest bank rescue since the Great Depression, as it prepares to clear troubled assets off lenders' balance sheets and get credit moving through the troubled economy.

Treasury Secretary Timothy Geithner next week is expected to unveil an ambitious plan putting the federal government in the central position of backstopping lenders against losses from hundreds of billions of dollars of "toxic assets" such as mortgage-backed securities. There's a palpable fear that without dramatic action, bank losses could spiral out of control as mountains of toxic debt soak up all the capital in lenders' books, including billions of dollars in current federal aid. Further erosion in banking would prolong and deepen the global recession.

"Banks provide the grease which lubricates the wheels of commerce; without that, the economy is frozen," says Samuel Hayes, professor of finance emeritus at Harvard Business School.

The numbers are staggering — U.S. commercial banks hold $3.8 trillion in residential and commercial mortgages, plus $700 billion in mortgage-related securities, according to Federal Reserve data. That represents close to half of banks' total financial assets of $9.8 trillion, as of Jan. 30.

Even though the Treasury Department has pledged nearly $350 billion in new capital to banks since early October, credit remains historically tight, and lenders are under growing stress as the value of mortgage-backed securities and other assets continues to fall. Companies across the country need access to credit to operate and make payroll. But 65% of lenders have tightened business credit terms in recent months, while many have cut existing lines of credit to firms and consumers.

The Obama administration is under intense economic and political pressure as it prepares its bank rescue plan. Lawmakers are furious about the way former Treasury secretary Henry Paulson managed the previous financial bailout, charging that Paulson lacked a clear strategy and wasn't upfront about how taxpayers' money was spent.

At a Senate Banking Committee hearing Thursday, Harvard professor Elizabeth Warren, who chairs a special Congressional Oversight Panel on the bailout, said the Treasury shelled out $254 billion to banks in 2008, in return for $176 billion in assets — a nearly $80 billion gap. Sen. Robert Bennett, R-Utah, said that if Geithner does not put forth an acceptable plan, "the political support for putting up the money will not be there."

Banks are failing regularly, six in January alone, compared with 25 in 2008 and three in 2007. The worst problems are centered in the nation's big banks, however, which are considered "too big to fail" because of the damage their collapse would cause the financial system. The government has poured $90 billion into Citigroup and Bank of America, two of the top 10 U.S. institutions that now control 70% of the country's banking assets.