Contact Us
Firm Overview
Why Legend Is Different
Client Types
Professional Biographies
Frequently & Rarely Asked Questions
Risk Spectrum
Investment Strategies
Second Opinion
Global Investment Pulse
Event Calendar
Press Center
Legend News
Clients Only
Career Opportunities
Newsletter Sign-up
Site Search
Site Map
Tell A Friend About This Website
Informational Booklets   
Phone: (412) 635-9210
  (888) 236-5960
Connect With Legend:
Subscribe to me on YouTube

The Obama Bank Plan And The Risks It Poses

No one knows whether it will work, though if you ask seven experts, you’re likely to get eight strongly held opinions. The broad outlines of the Obama administration plan to cure the ailing U.S. banking system were revealed in February, with a much more detailed blueprint unveiled in late March. Both announcements drew both praise and criticism; some detractors were so disenchanted that they called for the ouster of Treasury Secretary Timothy Geithner. But President Barack Obama has steadfastly supported Geithner and has called the plan a “critical element” in efforts to restore faith in the economy both here and abroad. Yet it poses substantial risks.

The bank plan takes shape.The latest plan follows hard on the heels of other initiatives that tried to address mortgage foreclosures, open up lending to small businesses, and break the logjam for many types of consumer loans. It allows the government to use $75 billion to $100 billion of the funds left in the $700 billion bailout program that Congress enacted in 2008. That money will be supported by loans from the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve.

How it works.Much of the new effort is aimed at relieving banks of “toxic” assets, bad loans that are weighing down balance sheets and causing banks to hoard capital rather than lend it. Now, under a typical arrangement, if $100 in bad assets is purchased from a bank, private-sector investors—primarily institutional investors such as insurance companies, pension funds, and hedge funds—would contribute $7. The government would also kick in $7, with the remaining $86 covered by a loan from the FDIC or the Federal Reserve.

Obama administration officials believe the program could clear away more than $500 billion—and possibly as much as $1 trillion—of toxic debt. And though it shifts the bulk of the burden for those assets to the federal government, Geithner has argued that failing to take bold action could lead to a much longer recession. In his view, inaction now would force the government eventually to carry all the risk for the bad assets. One benefit of involving private investors, according to Geithner, is that they may bid against each other to acquire the troubled loans, thus increasing payments to cash-hungry banks.

Risks abound.A major question is whether the government can afford to finance the new program. The effort is pushing the federal budget deficit to unprecedented levels, and that could ultimately push down the value of the dollar against other currencies and fuel rampant inflation. Even then, there’s no guarantee the Treasury plan will succeed at ridding banks of their toxic assets. They may resist pressure to sell assets at bargain-basement prices despite the government-financed incentives, instead holding out for more than the private sector is willing to pay.

If the government ultimately needs more than the $100 billion it has proposed spending, it may be hard pressed to come up with the money. It took two tries last fall before Congress was able to pass the financial bailout, and the public mood has soured considerably since then. Many people, outraged about big bonuses for banking and insurance industry leaders, no longer buy the argument that supporting the financial industry is a prerequisite for economic recovery.

In the worst-case scenario, a failure of the Treasury plan could scuttle the stock market rebound and deepen a recession that has already cost millions of jobs. Massive U.S. efforts to help the banking system have been going on since last fall, yet credit has remained extremely tight, limiting borrowing by consumers and businesses alike.

Many economists have suggested alternative approaches, including a temporary government takeover of the banking system. That worked in Sweden during the 1990s, when banks in that country were threatened by bad commercial real estate loans. But the size of the U.S. financial system dwarfs that of Sweden, and taking control of several large U.S. banks would also require huge government outlays.

Geithner has acknowledged that the government is taking risks with this latest plan to help banks and ease the credit crunch. But he argues that this approach to solving the crisis has the best chance to succeed. Only time will tell whether he’s correct.


This article was written by a professional financial journalist for Legend Financial Advisors, Inc. and is not intended as legal or investment advice.

©2018 Legend Financial Advisors, Inc.®. All rights reserved.