Foreclosure issues still a major hurdle

— -- It was the anticlimax of the new year.

After weeks of anticipation, U.S. Treasury Secretary Timothy Geithner on Tuesday outlined a plan to deliver as much as $2 trillion in public and private funds to the beleaguered financial system. But the plan landed with a thud on Wall Street, where stock markets dived as traders decided the proposal simply did not deliver the details and direction needed.

The reception was not much better on Capitol Hill, with lawmakers complaining that Geithner gave them too few specifics and failed to craft a promised companion plan to slow record home foreclosures, which President Obama has called critical to any economic recovery.

It was not an auspicious beginning for a program that administration officials have touted — along with the $838 billion economic stimulus bill passed Tuesday by the Senate — as crucial to restore battered confidence, repair the banking system and clear the way for credit to start coursing through the troubled economy.

"If we do not do enough now to solve this, then we're likely to suffer further loss of confidence in our financial management. And that will make it harder for us ... to try to solve theseproblems long term," Geithner told the Senate Banking Committee.

Most problematic for many analysts was that Geithner apparently failed to solve a problem that vexed the Bush administration — how to price trillions of dollars of "toxic assets" weighing down bank balance sheets. The new proposal calls for the government to partner with private investors to buy up as much as $1 trillion in assets but doesn't say exactly how.

"I don't call this a plan; it's a tease," said Bert Ely, principal at bank consultant Ely & Co. Ely said that among other things, he was nervous about how the government will handle the sales of assets. "The devil's in the details, but the details weren't there."

The administration's plan "is a huge step in the right direction, but the unanswered details could make or break the success of the program," says Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, which represents the nation's largest banks.

The administration may have hoped that the sheer scale of the plan would send a strong message that it is committed to doing whatever is necessary to pull the U.S. economy out of its worst crisis since the Great Depression. Geithner and Federal Reserve Chairman Ben Bernanke promised to work with lawmakers and businesses in coming days to flesh out the details.

The plan would be financed through a complex mix of federal tax dollars, private capital and an expansion of the Fed's balance sheet; essentially the central bank will print more money to finance consumer and business lending. For now, the administration is not asking for tax dollars above the $350 billion remaining of the $700 billion financial rescue bill passed in October. But Geithner suggested that more would likely be needed given the scope of problems besetting the banking industry.

"I'm not standing here before you today to ask you to authorize more resources. I want to be candid, though, that I think this is going to be an expensive problem for the nation, and it's going to require substantial resources," Geithner said.

The Financial Stability Plan has three main avenues to bolster financial markets.

•It would create an entity, as yet to be determined, using government and private funds to buy as much as $500 billion in toxic assets on bank balance sheets, and possibly as much as $1 trillion.

•It calls for using $100 billion in tax dollars to leverage as much as $1 trillion in auto, credit card, student loan and other lending under a Federal Reserve program.

•Treasury will also provide more capital to banks, and the largest ones will have to undergo a "stress test" to see if they are financially sound.

Assessing banks' strength

In a marked departure from the first round of the bailout, the government this time will determine which of the nation's largest banks are likely to need more capital and which are healthy enough to lend and even survive a worse recession than projected. Banks with assets above $100 billion will be required to undergo a "stress test" to assess the strength of their balance sheets.

Last year, the government gave out its first $125 billion to nine of the largest banks without assessing whether they needed it. CEOs of some of the banks are to explain how they spent the money at a hearing Wednesday before the House Financial Service Committee.

"This is a crisis, and it's important to do triage and figure out which institutions are solvent and which ones aren't," says Jonathan Macey, a corporate law professor at Yale University.

Only the largest banks are required to submit to this scrutiny, a recognition that some of the worst problems are in the nation's 20 largest banks, which control 80% of the country's banking assets.

"Any stress test would involve a close look at the quality of assets, strength of earnings, strength of existing capital and also the strength of management," says John Douglas, former general counsel for the Federal Deposit Insurance Corp. and chairman of law firm Paul Hastings.

However, it is unclear what happens to banks that do not pass the stress test. Douglas believes that the government could either fund the institution with more capital or take over the bank and sell it to private investors as it did in the case of IndyMac Bank.

Fund for bad assets

The Federal Reserve and the FDIC will partner with the private sector to create a market to buy troubled assets, many of them complex securities backed by bundles of mortgages and other kinds of loans.

This is the most complex part of Geithner's plan. Banks cannot sell those assets because there's no market for them, and that's made it difficult to assess their value.

The conundrum is that the government could pay a very low price, which would force the banks to mark down asset values too much, possibly driving them to insolvency. But if the government pays too much, taxpayers will take on more risk of future losses.

Geithner said the public-private investment fund, which would use government funds to leverage private capital, would initially seek to buy $500 billion in toxic assets, and could increase that to $1 trillion.

"By providing the financing the private markets cannot now provide, this will help start a market for the real estate-related assets that are at the center of this crisis," Geithner said.

SNL Financial senior analyst Sebastian Hindman says Geithner is seeking to create a market that doesn't exist today and hopes to generate demand by starting to buy bad assets, enticing private investors to jump in. "Geithner hopes to create as large of a market as possible with as little taxpayer money as possible," he says.

Jump-start lending

The government could commit as much as $1 trillion to an initiative to lubricate the market for consumer and business lending. It expands on a $200 billion program the Federal Reserve has been preparing to launch.

That money would provide financing to private investors to buy securities backed by credit card debt, auto loans, student loans and commercial mortgages. When banks can sell their loans into a healthy secondary market, that gives the banks new money to lend.

Geithner estimates that 40% of all consumer lending comes from banks' ability to sell off such debt.

This part of the plan highlights the Fed's growing commitments in the loans and guarantees it's made to the financial system.

In addition to the consumer-business lending program, the Fed has committed to buying $600 billion in debt and mortgage-backed securities from Fannie Mae and Freddie Mac.

However, as the Fed has become more aggressive, its balance sheet has ballooned to $2 trillion from $800 billion. Lawmakers at a Tuesday House Financial Services Committee hearing asked Fed Chairman Ben Bernanke sharp questions about the Fed moves.

"Not only has there been no disclosure or little oversight or accountability, but there's actually been an active resistance about explaining the terms of these deals," said Rep. Spencer Bachus, R-Ala.

Bernanke promised more transparency and said the Fed needed to keep looking for opportunities to unlock frozen credit markets.

The Fed's actions have been taken in response to the historic credit crisis, "not because we have some nefarious scheme," Bernanke said.

Foreclosure relief

Geithner promised to provide relief to homeowners by bringing down mortgage payments and mortgage rates, as a way to address the foreclosure crisis. However, he said that a "comprehensive plan" would be developed over the next few weeks.

As the mortgage crisis deepens, some believe that such a plan should be hammered out quickly.

"This is the source of what brought us the recession and continues to contribute stress to our economy," says John Taylor, CEO of the National Community Reinvestment Coalition.

Taylor called on the administration to move quickly on resolving the foreclosure crisis. "Go to the source of the fire and put it out," said Taylor.