Obama to Require Banks Receiving Aid to Boost Lending (Update1)

Feb. 2 (Bloomberg) -- President Barack Obama will require banks to boost lending to consumers and companies in return for taxpayer aid from the $700 billion bailout fund, in a departure from Bush administration policy, a key lawmaker said.

“You’re going to see the Obama administration,” learning lessons from the first phase of the program, “push for much more lending,” House Financial Services Committee Chairman Barney Frank, who helped write the financial-rescue law, said yesterday on ABC television’s This Week program. “There are going to be some real rules in there.”

Obama will include the restriction in a bank-rescue strategy he is expected to announce in coming weeks, responding to congressional criticism that firms receiving funds from the first $350 billion installment failed to pass on the aid. Obama last week blasted Wall Street executives for paying bonuses, and reports showed some aid helped recipients to finance mergers and acquisitions that may lead to job cuts.

The administration and top Democratic lawmakers are seeking to differentiate the next stage of the financial bailout in order to insulate against popular opposition to a Wall Street rescue. Lawmakers are questioning the effectiveness of the Troubled Asset Relief Program they enacted in October, saying the Bush team’s decisions on deploying the first $350 billion did little to stabilize the economy.

Announcement Coming

While the Treasury may not announce its TARP overhaul until next week, the administration is likely to unveil in coming days a new, stricter set of rules reining in executive pay for the biggest recipients of taxpayer funds, an administration official said. The requirements, which may also restrict dividends, would apply to companies that get exceptional government aid.

Obama said today that the U.S. is suffering from a “massive hangover” from years of risk-taking and that some banks remain “very vulnerable.” In an interview on NBC’s Today show, he said it’s likely some banks haven’t fully disclosed their losses.

“They’re going to have to write down those losses, and some banks won’t make it,” he said. Referring to the administration’s plan for the financial industry, he said “I do have confidence we’re going to get it right but it’s not going to be overnight.”

Geithner Meetings

Treasury Secretary Timothy Geithner will meet today with Federal Reserve Chairman Ben S. Bernanke, Federal Deposit Insurance Corp. Chairwoman Sheila Bair and Comptroller of the Currency John Dugan to continue discussions on regulatory changes. Frank will also meet with Bernanke.

Among other gatherings, Geithner is expected to attend a Democratic congressional retreat this week, while Citigroup’s incoming chairman, Richard Parsons, met with Treasury officials Jan. 30.

“We’ve got to loosen up the credit markets,” Senator James DeMint, a South Carolina Republican, said yesterday on ABC’s This Week. “The first round of TARP did not support lending, which was its whole point.”

Under former Secretary Henry Paulson, the Treasury allocated about half of the $700 billion program to inject capital into banks, help automakers, and guarantee assets for Citigroup Inc. and Bank of America Corp. In its rescue efforts so far, the Treasury has taken ownership stakes in more than 300 banks as a condition of providing aid.

TARP Overhaul

“It is a mistake to assume that the Obama administration hasn’t learned from the mistakes of the Bush administration,” Frank, a Massachusetts Democrat, said yesterday. “I believe they’re going to do it very differently.”

The U.S. House of Representatives last month approved legislation written by Frank that sets conditions for the release of the remaining $350 billion in funds.

The bill, which Frank acknowledged wouldn’t immediately be taken up in the Senate, is meant to serve as a guide for the Obama administration for how lawmakers would like to see the money spent. It would require the Treasury to set up a foreclosure-relief program and direct banks to report how they are using the funds.

During his confirmation hearing last month, Geithner told the Senate Finance Committee that he would expect banks to step up their lending activities in exchange for receiving government funding, particularly if the banks were in good shape to start.

Condition for Help

“As a condition of federal assistance, healthy banks without major capital shortfalls will increase lending above baseline levels,” Geithner said.

The president in his weekly radio address on Jan. 31 said the new strategy will “help lower mortgage costs and extend loans to small businesses so they can create jobs.”

One part of that strategy will be addressing the toxic assets that are clogging lenders’ balance sheets and preventing them from expanding credit, people familiar with the matter said last week. Likely approaches include a government-run bad bank to buy and hold some of the securities, and insurance of other assets that remain on banks’ books.

Officials and regulators are grappling with how to value the investments in a way that shores up the banking system while not exposing the taxpayer to potentially trillions of dollars of losses.

Buying illiquid assets amounts to swapping taxpayers’ “cash for trash,” Nobel laureate Joseph Stiglitz said in a Jan. 31 panel discussion at the World Economic Forum in Davos, Switzerland. “You shouldn’t chase good money after bad.”

Stiglitz Warning

Stiglitz, a professor at Columbia University in New York and a former adviser to President Bill Clinton, said the plan would leave taxpayers paying for years of imprudent lending by banks.

The same challenge of how to value the assets has been a sticking point ever since Paulson and Bernanke went to Capitol Hill to seek the original bailout legislation last year.

At the time, Bernanke said the government would need to pay above “fire-sale prices.” Paulson later ditched the plan, deciding that buying assets was too complicated and expensive, and switched the focus to capital injections in the hope that stronger banks could unwind their balance sheets on their own. That hasn’t happened, so the idea of purchasing troubled assets is under consideration again, posing the same set of issues.

“If you pay too much, the bank that’s selling the assets may inappropriately benefit,” Michael Bleier, a partner at law firm Reed Smith in Pittsburgh and a former Fed lawyer, said in a telephone interview. “If you pay too little, you might crater the institution.”

Staff Strains

Also, it takes a lot of staff to manage the assets once the government takes them on, Bleier said. Real-estate investments come with upkeep, tax and even development costs. That adds to the complexity of the project.

Obama’s blueprint is also expected to include a program for alleviating foreclosures. One approach could resemble a plan unveiled last year by Federal Deposit Insurance Corp. Chairman Sheila Bair to have the government use TARP funds to guarantee modified mortgages.

Bair’s proposal, which she said could prevent 1.5 million foreclosures through 2009, would create a program that would pay servicers $1,000 to modify a troubled loan by reducing the interest rate, forgiving a portion of the principal or extending the repayment plan. The government would then absorb as much as 50 percent of any loss if the modified loan re-defaults.

To contact the reporters on this story: Alison Vekshin in Washington at avekshin@bloomberg.net; Rebecca Christie in Washington at Rchristie4@bloomberg.net.

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