Breathe a sigh of relief: More than six months after the financial crisis erupted, a complete bailout regime is finally in place.
The bank rescue plan finally unveiled by Treasury Secretary Tim Geithner is the last major piece of a vast bailout scheme that's been evolving since last September, when Lehman Brothers failed and AIG and Merrill Lynch almost did. Having a full plan in place doesn't mean it will work. But regulators at the White House, Treasury, and Federal Reserve can now transition from designing the biggest financial bailout in 70 years – which could ultimately cost more than $2 trillion - to executing it.
If you've lost track of what the government is actually doing, you get a pass. The bailout efforts have developed in fits and starts, from TARP to TALF to a bunch of other arcane-sounding programs. (See Treasury’s official list.) Some have been scrapped before they even got started. Others have been rolled out quietly, then expanded to become major parts of the relief effort. And the bailouts don’t include stimulus spending, tax cuts, or monetary-policy maneuvers by the Federal Reserve.
The Obama administration now calls its various bailout efforts the Financial Stability Plan, and it’s developing a Web site to explain it all. Meanwhile, here's a quick scorecard to help track the government’s biggest moves, how much it's costing, and what the prospects for success seem to be:
Buying toxic assets. This was the original idea of the TARP - the Troubled Assets Relief Program, announced last October. But it's taken a long time for the government to actually relieve banks of any troubled assets, like mortgage-backed securities and related derivatives that have become unsellable and are clogging the financial system.
Geithner's latest plan, the Public-Private Investment Partnership, is basically a refined and expanded version on the original TARP, with some key differences. Instead of the government directly buying these securities from banks - with taxpayers bearing all this risk if the price turned out to be too high - Geithner's plan will use federal loans and other subsidies to help pools of private investors buy securities at discounted prices, in the hope that their value will rise as the economy and housing market recover. If sold for a profit in the future, the government and the private investors would split the gain. If the securities fall in value, both sides would lose – but the government would lose more.
Approximate cost: Details are still somewhat sketchy, but the government wants to fuel the purchase of up to $1 trillion in dicey securities. That could require up to $70 billion in government spending for equity stakes in the securities, and well over $500 billion in federal financing or financing guarantees. If the plan works, investors would repay the loans, and the government would earn a profit on its equity investments. But if the securities ultimately lose value, compared to what the partnership pays, taxpayers would bear most of the loss.
Prospects: Some big investors are enthused, others are skeptical. “The politics of this are very, very hard," Geithner said recently. If private firms get too much of a sweetheart deal, for instance, it could spark another public uproar like the furor over the AIG bonuses. But if the government limits the private upside, it could discourage participation. The government still needs to establish clear ground rules and procedures for auctioning off securities, which could take awhile. It might not be clear until summer or fall if the PPIP is working as planned, or if Geithner needs to come up with something else.
Recapitalizing the banks. During the Bush administration, the original TAPR morphed into a different plan, now known as the Capital Purchase Program, to inject money directly into banks, by buying preferred shares that could be converted into common equity. Obama and Geithner have basically left that in place. This money - including $45 billion apiece for Citigroup and Bank of America - hasn't been used to relieve anybody of their troubled assets. Instead, it's helped provide more capital to banks that are required to set aside funds to cover losses, helping keep them solvent.
Approximate cost: About $200 billion so far, going to about 500 institutions. (Here’s a list of recipients.)
Prospects: Theoretically, the CPP should help banks ramp up lending, since it provides capital they'd need to keep in reserve to cover potential losses. But banks that have been burned by bad loans have been reluctant to risk making more of them. Oh, by the way, just to make sure you’re paying attention, the Treasury Dept. will transfer some of the Capital Purchase Program expenditures to a new Capital Assistance Program, once it has run “stress tests” on 19 of the biggest banks to determine how healthy they are and how much more money they may need.
[See why the markets hate the idea of bank nationalization.]
Unwinding AIG. This corporate disaster is literally in a category all by itself, which Treasury has designated “systemically significant failing institutions.” Since AIG is an insurance firm that falls between the regulatory cracks – rather than a bank overseen by the FDIC or the Fed – propping up the teetering giant has required an ad hoc and immensely costly approach.
Approximate cost: So far, the government has committed about $180 billion – more than 10 times the Treasury Dept.’s own budget – to AIG, in exchange for an 80 percent stake in the firm. Much of the funding is in the form of loans from the Fed, with up to $70 billion more in investments from Treasury. More federal infusions are possible.
Prospects: Under new CEO Edward Liddy, AIG is basically being dismantled, to wind down a huge basket of explosive derivatives contracts and hopefully, one day, pay back the government. Many of the firm’s insurance lines and other businesses – which are solvent and healthy – are being prepped for sale or spinoff. But with a wretched economy, buyers are scarce, so the firm is waiting for more of a seller’s market to develop. It’s likely to take several years for AIG to complete a complex restructuring plan and pay back the government.
Saving the domestic auto industry. General Motors and Chrysler have gotten $17.4 billion so far, and they’re asking for up to $36 billion more. Obama’s automotive task force will soon decide whether to dole out more aid or let the firms fall into bankruptcy. Ford hasn’t asked for any bailout money yet, but some analysts think it may have no choice eventually.
Approximate cost: $30 billion so far, including loans to auto-finance companies and parts suppliers. If the government grants the automakers’ latest requests, total aid to Detroit could hit $65 billion this year – with a chance it could ultimately total more than $100 billion.
Prospects: Even a total bailout won’t make Detroit as competitive as it needs to be, which is one reason some analysts think a conventional bankruptcy filing would help GM restructure itself faster and more dramatically. Chrysler, which is smaller and weaker than GM, probably wouldn’t survive bankruptcy, and even with a bailout it may not make it.
[See 6 upsides to a GM bankruptcy.]
Restoring consumer credit. This Federal Reserve program has one of the worst acronyms in Washington – the TALF, or term asset-backed securities lending facility – but it could be an important source of new funding for car, student, and small business loans, as well as credit-card lending. The Fed doesn’t make direct loans to consumers, so instead, it will lend money to investors who want to purchase securities backed by consumer loans. This kind of securitization used to be a key part of the credit markets, helping keep money flowing to consumers. Now, with rampant fears of credit losses, it’s almost completely stopped. To get it started again, the Fed will bear the risk of losses and limit financing to the highest-rated securities.
Approximate cost: Up to $200 billion, which theoretically should be repaid to the Fed within five years.
Prospects: This program was first announced last year, but has taken months to refine and ramp up. A few early deals indicate that investors are taking the bait: “The completion of the deals suggests the Fed is having some success,” wrote analyst Neena Mishra of Zacks Investment Research recently.
[See 5 Wall Street fallacies.]
Homeowner bailouts. The Making Home Affordable program could help 3 to 5 million homeowners lower their monthly mortgage payments and avoid foreclosure, by paying banks fees and offering other incentives to lower interest rates and rework loan terms for people. Other parts of the program are meant to lower overall interest rates and make more people eligible to refinance.
Approximate cost: $75 billion.
Prospects: The plan seems likely to rescue some struggling homeowners, but others will still find help out of reach. Foreclosure rates are still likely to rise, but by less than they would without the program.
[See why the feds rescue banks, not homeowners.]
Will all of this work? It depends how you define success. Extraordinary government efforts have clearly calmed the panic that seized the financial markets last fall, and even the morose stock markets have welcomed the bank-rescue plan. But the price tag is extraordinarily high, and even a best-case recovery will take months.
Meanwhile, there’s plenty that could go wrong. Investors could balk at the partnership plan. The banks’ condition could turn out to be even worse than feared. Another political firestorm like the AIG bonuses could wreck public support for any bailout. And the overall economy could sink faster than expected. If the worst comes to pass, Geithner still has one more option: Start over.