WASHINGTON — Taking the wraps off its much anticipated bank-rescue plan, the Obama administration on Wednesday announced that it will provide a virtually unlimited solvency guarantee to the nation's 19 largest banks.
Shortly after Treasury unveiled details of its plan, President Barack Obama appeared before TV cameras with congressional leaders to launch what he hopes will be a quick move to replace what he called a 20th century financial regulatory system.
"This financial crisis was not inevitable," Obama said, noting that his goal wasn't to inhibit the free market but to regulate it better to prevent a repeat of the global meltdown now occurring.
Treasury Secretary Timothy Geithner unveiled the administration's bank-rescue plan on Feb. 10, and financial markets tanked as investors fretted over a lack of detail.
Markets got those details Wednesday and the Dow Jones Industrial Average initially recovered from a loss of 200 points in mid-afternoon trading. However, that rally faded, and the Dow closed the day down 80.05 points to 7270.89. Other market indexes were off by similar margins.
While investors appeared to cheer the confidence-boosting design of the Capital Assistance Program, it may prove less popular with taxpayers because it amounts to a blank check to ensure that the top banks — those with assets over $100 billion — remain solvent.
The plan works like this: Through the end of April, federal regulators will pore over the books of the 19 largest banks — such as Citigroup, Bank of America, Wells Fargo and others. They'll be looking at conventional measures such as the composition of a bank's cash on hand, and at unconventional ones, such as how financial firms are valuing complex and opaque investments that are often shorthanded as toxic assets.
The idea behind the so-called stress tests is to gauge if the banks have enough capital to cope with a more severe downturn than even today's — one in which the economy contracts by 3.3 percent and the unemployment rate tops 10 percent. That's far from the worst-case scenarios that some of the gloomier forecasters predict.
"Supervisors will work with institutions to estimate the range of possible future losses and the resources to absorb such losses over a two-year period," said a joint statement from four federal bank regulators — the Federal Reserve, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and the Office of Thrift Supervision.
At the end of the exercise, if it's determined that banks lack enough capital to weather such a storm, they'll be given six months to raise more capital from private investors or to ask for a capital buffer from the government.
"The more specificity, the less uncertainty, the more it does provide banks an opportunity to raise private capital . . . is frankly the right way to go. It clearly is a time frame that I think is reasonable," said Stuart Hoffman, chief economist for PNC Financial Services, one of the 19 firms that will be put through the stress test.
If a bank is unable to raise private capital and needs to get capital from the federal government, it would do it in exchange for "convertible mandatory preferred shares." They could be converted into common stock on an as-needed basis, which would inject new capital into the bank. The government would become a shareholder in the company through its ownership of common stock.
Banks don't have to complete the stress test to apply for this capital buffer. Citigroup is expected to get a fresh injection of capital through this program in coming days. In exchange, the government is expected to take a stake as high as 40 percent.
The administration's plan has two goals. One is to ensure that banks have adequate capital cushions to withstand any downturn. The other goal is to restore investor confidence by showing that these big financial firms have access to as much money as they need, because the government is willing to invest as needed.
How much will it cost? No one is saying.
There’s no price tag on the CAP, at least until the stress tests are over in April. If most of the 19 banks were determined to need additional capital, the Obama administration would have to seek much more Wall Street bailout money from Congress.
"The fact is there is no explicit cap on the assistance that can be provided under this program," said one senior government official on the condition of anonymity to speak freely.
Whether the plan will work depends in part on whether other components of the administration’s rescue effort prove effective. Those include the public works spending envisioned in the $787 billion stimulus plan and an effort coming next week from the Federal Reserve to serve as the buyer of last resort for pools of securities backed by loans for new cars, students, small businesses and credit-card debt.
Few analysts are willing to guess whether Obama’s plan ultimately will work.
"I don't know what its going to take to calm the markets at this point, because everyone is just so paranoid that it's hard to know," said David Wyss, chief economist for the rating firm Standard & Poor's in New York.
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