Pain will persist despite crucial bailout antidote

Analysis:America's new plan for bailing out its banks is a critical, yet inevitably painful, restorative for the global financial system, experts say.

Tim Geithner, the Treasury Secretary, unveiled how the US government propose to spend the $350 billion left over from last year's $700bn TARP.

This next part may hurt a bit. America's new plan for bailing out its banks is a critical, yet inevitably painful, restorative for the global financial system, experts say. While it may set the stage for a recovery by the world's largest economy, they warn that its immediate effect on capital markets is likely to be anything but pleasant. The US Treasury secretary, Timothy Geithner, was set to unveil yesterday details of how the administration of President Barack Obama would use the US$350 billion (Dh1.28 trillion) left over from last year's $700bn troubled assets relief programme (TARP) to revive US banks and get them lending again. The plan, details of which were leaked to reporters after White House briefings on Monday to members of the US Congress, relies in part on convincing private investors to help share the cost - and risk - of buying up the dud securities suffocating the banks. It imposes new restrictions on banks that get government funds, and aims to help Americans avoid losing their homes to foreclosure. "The focus is going to be on increasing the flow of credit and doing it with transparency, with accountability for those who receive support, and with a kind of consistency that, frankly, we haven't seen so far," Lawrence Summers, the director of the US National Economic Council, said in an interview on Sunday on ABC, the US television network. "So, yes, there will be support for banks so that they remain stable, are in a position to lend." Economists agree that resuscitating the banks is a prerequisite to unleashing the administration's fiscal stimulus plan of about $800bn, which Mr Obama is trying to push through Congress this week. Without healthy banks, they say, government spending will gain little traction. Yet concerns remain that, in the process of extricating banks from their toxic assets, the US may trigger an avalanche of write-offs. "There is a concern that once you set a price for these assets the banks have to revalue them at the price that has been paid," said Charles Seville, the associate director of sovereign and international public finance at Fitch Ratings in London. Further capital injections could also touch off a new wave of government bailouts akin to last year's, economists say, when Britain's move to shore up banks compelled governments across Europe and the US to do the same. Perhaps the most profound side effect of the new phase in the US bank bailout, though, could be a more protracted drought in international capital markets, worsening the credit crunch across Asia and the Gulf. "These things will come with strings attached. The basic rationale behind them is to get domestic credit flowing. It's not to free up international credit," said Farouk Soussa, the director of sovereign ratings at Standard & Poor's in Dubai. "Countries that have been dependent on importing international capital will feel the credit constraints continuing." The Institute of International Finance in Washington recently estimated global net inflows of private capital would drop to $165bn this year from a peak of $929bn in 2007, led by a retreat in overseas bank lending from developing ­economies. Mr Geithner's plan is targeted principally at helping banks clear the hundreds of billions of dollars worth of subprime mortgage-related securities they created during the credit bubble. When the US housing market collapsed last year, the market for these mortgage-backed securities, collateralised debt obligations and other asset-backed credit derivatives collapsed, pulling the global interbank market down with it. The subsequent freeze in global credit helped throw the world into the worst economic downturn since the Great Depression. Shrinking economies has in turn fed the rot in credit markets, with the infection spreading from subprime mortgages to mortgages of otherwise healthy borrowers, commercial real estate, corporate loans, car financing and credit cards. The damage has spread to virtually every corner of the globe, into economies once thought inured to the malaise. In the Gulf, for example, the combination of dwindling global consumer demand and fleeing global investment have triggered a collapse in oil prices, threatening regional exports and government finances. Evaporating global credit has sparked a regionwide credit crunch, ending the region's property boom and sparking a wave of layoffs in the construction and real-estate sector. Mr Geithner was scheduled to announce the new plan at 11am yesterday in Washington. He was reportedly prepared to announce the new bailout plan on Monday, but administration officials decided to push it back in order to focus public attention on Mr Obama's appeal to Congress to pass the stimulus package. Nonetheless, Mr Geithner and White House officials were said to have spent days convincing sceptical Congress members of the plan's efficacy. In many respects, the new plan appears to mark a return to the original objectives of the TARP enacted by the Bush administration while Mr Geithner was still president of the Federal Reserve Bank of New York. TARP initially aimed to buy up distressed assets from banks, but after a delay in its passage by Congress rattled financial markets and Britain moved to recapitalise its own banks, Mr Geithner's predecessor, Henry Paulson, said TARP would be used to inject capital directly into the nation's banks. The so-called toxic assets remained on the recapitalised banks' books, continuing to eat into their balance sheets as other good assets followed the economy downward. The new package reportedly reflects the belief among Obama officials that TARP was not only misdirected, but that it was too small. Mr Obama said as much in a news conference on Monday, his first as US president. "We don't know yet whether we're going to need additional money or how much additional money we'll need until we see how successful we are at restoring a level of confidence in the marketplace," Mr Obama said. "This is not your ordinary, run-of-the-mill recession, we are going through the worst economic crisis since the Great ­Depression." The plan also seeks to redress criticism that TARP gave bankers carte blanche to use taxpayer funds, a perception reinforced when it emerged that Wall Street had paid top executives nearly $20bn in bonuses for last year despite the crisis, payments that Mr Obama decried as "shameful". Mr Geithner reportedly fended off White House officials, however, who wanted to fire bankers at institutions that receive money, or impose further limits on executive pay. Some had also sought to dictate how banks should use any rescue funds. According to details released prior to Mr Geithner's announcements, the government would create a separate entity that would in turn buy troubled assets alongside private investors. The government would reduce the risk to those investors by guaranteeing to cap any losses they suffer on securities bought. Banks would then be able to apply for capital injections but only after passing a stress test to gauge their survivability. They would also have to disclose how they use federal funds, something banks have not had to do under TARP so far. The plan will also expand the Fed's role in lending working capital to corporations, and to institutions that provide loans to consumers and small businesses. The plan was also said to offer direct assistance to homeowners, though it was still unclear how. [e-mail]