/ 15 February 2009

The biggest challenge yet

Staff Photographer
Staff Photographer

President Barack Obama’s administration this week outlined a $2-trillion plan to rescue the United States’s ailing banking system with a stark warning that the country’s financial system runs the risk of “complete collapse”.

Unsparing in his description of the severity of the credit crunch, treasury secretary Timothy Geithner said the US was in the midst of its worst economic crisis in generations with a “challenge more complex than any our financial system has faced”.

The latest initiative came as the US Senate approved, by a narrow majority, a stimulus plan of tax cuts and public spending intended to bolster a sagging economy. More than three million jobs were lost in the US last year and a further 600 000 were lost last month.

The Bill just scraped over the 60 mark needed in the 100-member Senate. Fifty-eight Democrats were joined by three moderate Republicans, with 37 Republicans voting against.

Obama hopes to sign the Bill, which could make or break his presidency, on Monday. But tough negotiations lie ahead in Congress over the next few days, as the Senate and the House of Representatives haggle over differences.

Accusing his predecessors in the Bush administration of failing to grasp the scale of the problem, Geithner outlined a new strategy to develop a public-private partnership in cleansing toxic assets from teetering financial institutions.

“This strategy will cost money, involve risk and take time,” said Geithner in a speech that sent US share prices into a tailspin.

“As costly as this effort may be, we know that the cost of a complete collapse of our financial system would be incalculable for families, for businesses and for our nation.”

Banks in the US are to undergo “stress tests”, loosely modelled on medical check-ups, to judge their financial vulnerability.

To vacuum up toxic assets, including mortgage-backed securities and high-risk derivatives, the treasury will set up a public-private investment fund that will use taxpayers’ money to underwrite private capital. The fund will start at $500-billion, rising to $1-trillion in investment capacity.

In an initiative intended to encourage banks to extend credit again, the US government will devote $1-trillion to guaranteeing loans made by high-street institutions for new cars, mortgages and commercial projects.

Fresh money will be pumped into keeping struggling homeowners in their properties.

The treasury is setting up a website allowing taxpayers to track how banks are spending their money.

“The United States has to send a clear and consistent signal that we will act to prevent the catastrophic failure of financial institutions that would damage the broader economy,” Geithner said.

Two weeks after being sworn in, Geithner acknowledged public frustration over tales of seven-figure bonuses, boardroom excess and lavish corporate getaways at banks benefiting from taxpayer largesse.

“Access to public support is a privilege, not a right. When our government provides support to banks, it is not for the benefit of the banks; it is for the businesses and families who depend on banks.”

Geithner’s initiative replaces efforts by former treasury secretary Henry Paulson to recapitalise banks. Paulson, who left office when Obama became president, was criticised for an approach that switched tack as the financial crisis worsened.

Yet the new plan has failed to attract universal confidence, with sceptics on Wall Street questioning whether banks will be able to sell their toxic assets without taking vast write-downs in their book value, which would lead to further losses of tens of billions of dollars.

Martin Slaney, head of derivatives at GFT Global Markets, said: “The initial reaction is clearly one of disappointment. It’s always going to be difficult for the plan to live up to the hype.”

Some regard the proposals as little more than a variation of ill-fated efforts by the treasury last year to use public money to buy banks’ distressed assets.

Analysts RBC Capital Markets have predicted that more than 1 000 US banks may fail over the next three to five years as struggling businesses default on commercial loans and homeowners fail to keep up mortgage repayments.

The Obama administration has warned that it will take a tougher line on any profligate spending by banks.

But Geithner is said to have prevailed over hawks in the White House who wanted more radical steps, including the removal of senior executives and the obliteration of any remaining value in banking shares. —