Geithner Must Set Strategy for Bank-Stake Sales, Inspector Says

Feb. 5 (Bloomberg) -- Treasury Secretary Timothy Geithner needs to detail his intentions for the more than $200 billion of government stakes in U.S. banks to quell confusion in financial markets, according to a new oversight report.

“Treasury needs to begin developing a framework for its overall investment strategy,” Neil Barofsky, special inspector general of the Troubled Asset Relief Program, said today in his first review of the fund. “How long these securities should be held -- and when and under what circumstances they should be sold into the market -- are vitally important questions.”

The report underscores concern at a lack of clarity over the government’s exit strategy; shares of the banks that have received taxpayer funds fell more than four times the Standard & Poor’s 500 Stock Index in the past three months. The issue is set to grow as the Obama administration plans another round of capital injections into major financial companies.

“It is a huge challenge” to revamp the TARP, Kurt Karl, chief U.S. economist at Swiss Reinsurance Co. in New York, said before the report. “It’s not just investor confidence in banks, but it’s a general equity confidence, corporate debt confidence, banks amongst themselves confidence -- all these markets that have become less liquid hopefully become more liquid as the package rolls out.”

Consumer-Loan Program

Barofsky also urged additional protections against fraud in a new government program designed to revive the market for securities backed by credit-card, auto and student loans. The Federal Reserve, backed by $20 billion of TARP funds, plans to start the so-called Term Asset-Backed Securities Loan Facility this month.

There’s a danger of “lax underwriting” behind the loans, and a risk that the debt is improperly graded by ratings companies, the report said. Treasury General Counsel Bob Hoyt responded that the Fed is charged with responsibility to ensure the assets are handled properly.

The Treasury has committed about $300 billion of the TARP to purchase shares and guarantee assets of financial institutions, as well as loans and share purchases to bail out American automakers.

“We will have to do more, substantially more, to fix this crisis,” Geithner said yesterday at the White House. “This program will be directed at supporting the flows of credit that are essential for our economy to begin growing again.”

Summers Warning

Lawrence Summers, director of the White House’s National Economic Council, warned that the economy is at risk of foregoing $2 trillion of goods and services in the next two years without an all-out effort to fight the crisis. He also urged Congress to approve a fiscal stimulus plan in the “$900 billion range.”

Officials are planning a combination of approaches for their overhaul of the TARP. Along with further capital injections, the strategy is likely to include guarantees for illiquid assets that remain on banks’ balance sheets, and some form of a so-called bad bank that would purchase toxic investments.

“It’s a combination of things,” Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, told reporters yesterday in Washington. “It’s sort of like dealing with a cancer. There are a lot of different strategies that can work.”

Some analysts continue to press for a more radical approach, with the government forcefully splitting banks into “good” and “bad” units.

‘Lot of Confusion’

“There seems to be a lot of confusion and there does not seem to be the will to do that in Washington,” Janet Tavakoli, president of Chicago-based Tavakoli Structured Finance, which advises banks and hedge funds, said in a Bloomberg Television interview. “I do not know why we’re trying to push this response to the U.S. taxpayers,” she said. “The debt holders in those banks are the ones that should be bearing the risks.”

Officials in charge of the TARP didn’t dispute Barofsky’s observations about the rescue program’s initial stages.

“Treasury shares your view that transparency in the TARP is critical for keeping the public’s trust and for protecting the taxpayer’s money,” Neel Kashkari, interim Treasury secretary for financial stability and the director of the TARP, said in a Feb. 3 letter to Barofsky.

Treasury spokesman Isaac Baker said “many of these recommendations are already being implemented, including designing important safeguards to protect taxpayer dollars and strict requirements for asset-backed securities that will be used as collateral for TALF loans under the program.”

New Measures

Next week’s announcement on a financial-recovery plan will include strengthening “transparency and accountability measures so that taxpayers know where and how their money is being spent and whether it’s achieving real results,” Baker said in an e-mail.

Reacting to public outcry over bonuses paid to bankers getting government bailout money, the administration is also imposing conditions that would impose greater oversight of expenses such as corporate jets, office renovations, entertainment and holiday parties, and restrict senior executives’ severance pay.

While salaries would be limited, there are provisions that would allow additional compensation in the form of restricted stock that can’t be sold until taxpayers have been paid back with interest. Senior executive compensation plans also must be submitted to a non-binding shareholder resolution.

Former Fed Chairman Paul Volcker, an adviser to President Barack Obama, yesterday urged “particularly close regulation and supervision” of large commercial banks and other financial institutions whose failure would cause a breakdown in the U.S. banking system.

“Fundamental changes and reform of the financial system will be required to assure that strong, competitive and innovative private financial markets can in the future again support economic growth,” Volcker told lawmakers yesterday.

To contact the reporters on this story: Robert Schmidt in Washington at rschmidt5@bloomberg.net.

To contact the editors responsible for this story: Chris Anstey at canstey@bloomberg.net.