How long will cleanup take?

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Chicago Tribune

CHICAGO -- The government is starting a new waste-hauling business, driving up to the nation's leading financial institutions and giving them a fresh start by taking the garbage off their balance sheets.

Once it collects all that trash, the government is expected to hold the world's largest garage sale of distressed securities and bad mortgages and business loans. Years from now, when the dust clears, the U.S. might even make money on the deal.

But before that happens, hundreds of billions in taxpayer dollars will be committed to shoring up the toxic debt piled high in the nation's banks and investment firms.

No one knows how long the clean-up will take, or what surprises await as the housing crash runs its painful course. And no one can say whether intervening with the full faith and credit of the United States today will encourage reckless risk-taking in the future.

Much depends on the ability of the government to drive a hard bargain when it acquires the assets.

"If they value these things at fire-sale prices, they could make the banks secure and make more money," said Douglas Diamond, professor at the University of Chicago's Graduate School of Business. "If they get snookered, they could lose a lot."

The Bush administration is expected to seek sweeping new powers from Congress next week to pull off its still-sketchy rescue plan. The bailout could operate through a newly formed federal agency, in the same vein as the Resolution Trust Corp. established two decades ago to unwind failed thrifts.

In that case, the government took control of S&Ls and sold off their troubled loans and foreclosed real estate, usually at a loss. Entire institutions were offloaded to investors at deep discounts, and in some instances the bottom feeders who snapped up the properties made fortunes when real estate markets bounced back.

This time, many of the investments in question consist of individual mortgage loans packaged together by the thousands, and they're notoriously difficult to value in a sinking housing market. So-called mortgage-backed securities have fetched 25 cents on the dollar in recent transactions, which means the government might prefer to buy and hold until conditions stabilize.

That could involve a long wait, especially if the nation's financiers start confessing more and more sins, noted turnaround consultant Bill Brandt of Development Specialists in Chicago. "Some of the banks haven't told the truth to the public about how bad it really is."

A key issue in the giant workout: who gets to dump their distressed assets on the government.

"Everybody will want to get into this tent," said Washington University banking professor Stuart Greenbaum. "Commercial and investment banks will be in, but how about insurance companies, hedge funds, private equity shops?"

The idea of the government bailing out private funds that cater to wealthy clients would have gone nowhere in Congress before this week's events. But the fear that ran rampant on Wall Street appears to have swept away such objections.

As of Friday, details of the government plan remained undecided. The simplest option would be buying troubled assets, which would boost the capital reserves of the institutions, perhaps in exchange for an ownership stake, Greenbaum said. Or the government could take on troubled assets as collateral for loans, charging a hefty interest rate and potentially demanding equity stakes as well.

Brandt believes the government's financing options will vary, depending on the condition of the firm, with stronger institutions getting less assistance and keeping their autonomy. "It will be bank-by-bank," he predicted.

All this offloading is needed before banks can lend freely again, which is crucial to reviving the economy. The scale of the cleanup, while still unknown, is likely to equal or exceed the S&L bailout, which ultimately cost taxpayers an estimated $130 billion as of 1996.

The government also could draw on an even more remote historical precedent. Banking consultant Bert Ely said the plan could closely resemble the Home Owners' Loan Corp. of the 1930s, which bailed out about a million home mortgages during the Depression.

The agency bought loans at a discount, leaving the banks to record losses on them, then supplied homeowners with new mortgages. If the owners defaulted, the government rented those homes for a few years and eventually resold them.

"By that time," Ely said, "it actually made money for the government."

By Susan Chandler and Greg Burns

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