Treasury Weighs Hard Choices To Save Banks

The rapid deterioration of the economy has accentuated these hard choices. The health of many banks is getting worse, not better, as the downturn makes it difficult for all kinds of consumers and businesses to pay back money they borrowed from these financial firms. Conservative estimates put bank losses yet to be declared at $1 trillion.

Senior administration officials are likely to try a combination of initiatives rather than pin their hopes on a single, all-encompassing solution to help the financial system, the sources said. But their strategy may require trial and error, which could make them vulnerable to the same criticism that dogged the Bush administration's fitful management of the $700 billion rescue program.

On the table are several approaches, which officials have begun to experiment with on a smaller scale. One would give the firms a federal guarantee protecting them against losses on assets that are backed by failing mortgages and other troubled loans. Another would set up new government institutions to buy these toxic assets. A third would inject more money into financial firms in exchange for ownership stakes, perhaps ending with nationalization in all but name.

But each proposal is fraught with the risk of undermining the banking system, leaving Obama officials wrestling with how to strike the proper mix of emergency programs funded from the balance of the government's initial rescue program and any additional money requested from Congress.

Publicly, these officials said they plan to provide clearer guidelines and oversight for how government money is spent and promised to use rescue funds to help homeowners, small businesses, municipalities and other consumers as part of a comprehensive plan, which could be released this week or next. But other senior government officials and economists said they expect the bulk of the rescue funds to continue going to financial firms.

To date, the government has focused its efforts on offering federal funds to banks in exchange for ownership stakes. But the prices of bank shares are so low now that the government risks owning these firms outright if it makes a major investment of taxpayer money.

Explicit nationalization of financial companies has little support among key Obama officials, sources said. Treasury Secretary Timothy F. Geithner and top White House economic adviser Lawrence Summers think governments make poor bank managers and cannot efficiently manage a vast number of institutions, according to some of their associates.

Another danger is that by taking over a substantial portion of a bank's stock and wiping out the investment of the firm's other shareholders, the government could also precipitate a sell-off across the banking system as investors flee, fearing they could be next.

For this reason, the government may need to find a way to safeguard existing shareholders when it provides aid, though this is likely to spur anger by lawmakers and their constituents, a source said.

These risks do not eliminate nationalization as an option. The government would likely leave open the option for companies on the verge of collapse that are deemed critical to the financial system, officials said. Federal officials adopted this approach for insurance giant American International Group, which was largely taken over by the government in September. Officials are also playing a major internal role in the restructuring of Citigroup, which has received $45 billion in government aid, banking analysts said.

The proposal to set up new government institutions, or "bad banks," to buy up troubled assets harkens back to the original purpose of the $700 billion Troubled Assets Relief Program, or TARP, which was passed by Congress in October.