The Incredible Shrinking Obama Bailout Plan


The Obama administration is expected to announce its banking bailout package on Monday, and the latest anonymous reports should do little to reassure investors in the banks. The final plan is all but set, according to a “source familiar with the matter” who spoke to CNBC.

So what’s in the new plan?

  • No Giant Bad Bank. The huge government sponsored bank that would aggregate the troubled assets of banks is dead. The price tag of the bad bank was coming in at trillions of dollars, far to much for even the Obama administration to stomache.
  • Guarantees of asset values. Politicians love guarantees because they can pretend they are a free lunch. You don’t spend anything now and the costs wind up hitting at some point in the future. The idea here is for the government to “ring fence” or “backstop” certain assets by insuring them against losses beyond a certain level.
  • A Small Bad Bank. Sheila Bair has not been totally shut down in her dream of running a bad bank. The new bailout will probably include a much smaller bad bank that will buy up some assets, recapitalizing banks by handing them hard cash in exchange for soggy mortgage backed securities. 
  • Pricing issue resolved? With both guarantees and troubled asset purchases, the problem has always been how to price these things. Price the troubled assets too high and you are guaranteeing huge losses. Too low and banks will balk or, if you force them to sell, get wiped out. The administration appears to be ready to price the stuff at some discount to where banks are now carrying the assets on their books, but not all the way down to actual market prices “firesale prices.” This might take the form of, say, a 10 per cent discount for assets sold to the small bad bank. Sadly, this creates a perverse result of rewarding banks that refused to mark their books to reality.
  • Suspend mark to market. The discounted asset purchases would obviously mean the banks would have to take steep haircuts on their remaining assets. So they may just suspend mark to market, allowing banks to go on pretending that we’re in a market “dislocation.”
  •  decided on a new package of aid measures for the financial services industry, including a bad bank component, and is expected to announce them next Monday, according to a source familiar with the planning

“Everybody seems to like that,” said the source. “There’s a lot of internal conflict about whether this [the bad bank] makes sense … they realise they have to do something with the bad bank.”