FDIC May Run "Bad Bank"

Bloomberg has an article on: FDIC may run Bad Banks

The Federal Deposit Insurance Corp. may manage the so-called bad bank that the Obama administration is likely to set up as it tries to break the back of the credit crisis.

U.S. stocks gained, extending a global rally, on optimism the bad-bank plan will help shore up the economy. The Standard & Poor’s 500 Stock Index rose 2.4 percent, Bank of America Corp., down 54 percent this year before today, rose 15 percent. Citigroup Inc., which had fallen 47 percent this year, climbed 18 percent.

FDIC Chairman Sheila Bair is pushing to run the operation, which would buy the toxic assets clogging banks’ balance sheets.

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The bad-bank initiative may allow the government to rewrite some of the mortgages that underpin banks’ bad debt, in the hopes of stemming a crisis that has stripped more than 1.3 million Americans of their homes. Some lenders may be taken over by regulators and some management teams could be ousted as the government seeks to provide a shield to taxpayers.

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Still, nationalization of a swath of the banking industry is unlikely. House Financial Services Chairman Barney Frank said yesterday “the government should not take over all the banks.” Bair said earlier this month she would be “very surprised if that happened.”

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Obama is under increasing pressure to drastically revamp the $700 billion Troubled Asset Relief Program for the ailing industry. While setting up a bank to buy underwater assets is emerging as a favored approach, it could drive up the cost of the rescue in excess of $1 trillion.

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Billionaire investor George Soros said in Davos today the plan to buy toxic assets won’t be enough to get financial institutions to start lending again. “It’s not the measure that would turn the situation around and enable the banks to lend. You are nationalizing the debt and keeping the upside in private hands.”

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A key question for the bad bank would be how to value the toxic assets it would buy. Geithner, outlined three possible alternatives: look at how the market is pricing similar assets; use computer model-based estimates from independent firms; and seek the judgment of bank supervisors.

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Bair has said that cash from the TARP may help capitalize the bad bank and that commercial lenders may kick in some money of their own. One possibility that’s been discussed is issuing firms some kind of stock in the new organization as partial payment for their impaired assets.

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The government will likely use its ownership of toxic assets to rework soured mortgages and prevent foreclosures.

The financial sector stocks and ETFs are taking off today. Financial Select Sector SPDR (XLF) is up 11% today. WellsFargo is up 25%, Citi is up 17% and Bank of America is up 15%. These are mind-blowing returns for a day. The question is how long will this rally continue ? Again and again we have seen these rallies fizzle out.