Obama walks tightrope on banks

John W. Schoen Senior producer • Profile • E-mail

The Obama administration is trying to craft a plan that would give the government direct ownership of some banks without scaring away private investors who remain a potential source of badly needed capital.

Call it what you want, but no one wants to call it nationalization.

Worries about possible bank failures have intensified in recent days, prompting a broad and steep selloff in the stock market. In response, the five major federal bank regulators issued an unusual joint statement Monday morning, declaring that “the U.S. government stands firmly behind the banking system during this period of financial strain.”

After months of sliding from one crisis to another, and after a government injection of nearly $350 billion, the nation’s banking system remains fragile. The share prices of the biggest, most troubled banks, including Citigroup and Bank of America, have fallen into the low single digits, helping push broad stock market indexes to their lowest levels since 1997.

Souring loans on the books of many banks will yield more losses that could wipe out the remaining value of those shares, rendering the banks insolvent. Some fear that the biggest banks in the worst shape already have insufficient assets to meet their obligations.

Ever since the financial meltdown began over a year ago, banks have been struggling to shore up their capital base to withstand continued losses from loans gone bad. Initially confined largely to home mortgages, there are rising concerns about possible defaults on other types of debt, including commercial real estate loans, student loans, auto loans and credit card debt.

Late last month, the International Monetary Fund projected that worldwide banking industry losses may reach $2.2 trillion, up from a previous estimate of $1.4 trillion. The report estimated that the capital shortfall needed to cover those losses for U.S. and European banks alone was at least a half-trillion dollars.

"Going forward, banks will need even more capital as expected losses continue to mount," the bank warned.

It’s uncertain how much more capital will be needed. Part of the problem is that it is extremely difficult to value the “troubled” assets on the banking industry’s books. For example, some borrowers who are current on their loans today are at risk of defaulting if the economy continues to deteriorate. But if they do not default, the loan could be worth the full value.

That’s why the Obama administration is undertaking a “stress test” of troubled banks’ financial statements before dispensing the second half of a congressionally approved $700 billion to rescue the industry. The goal is to try to get a better estimate of how much more financial damage may be inflicted by the deteriorating global economy, and in turn, whether the package may need to increase.

In good times, banks turn to the capital market to raise additional cash. But private investors have been spooked by banks’ continuing losses and uncertainty over how much further the global economy will deteriorate.

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