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It may take trillions to right economy

Obama calls for new approach

Timothy Geithner, President Obama's nominee for Treasury secretary, at his Senate confirmation hearing yesterday. He said the new administration's economic plan includes ''fundamental reform'' of the $700 billion financial rescue package. Timothy Geithner, President Obama's nominee for Treasury secretary, at his Senate confirmation hearing yesterday. He said the new administration's economic plan includes ''fundamental reform'' of the $700 billion financial rescue package. (Brendan Hoffman/Getty Images)
By Robert Gavin
Globe Staff / January 22, 2009
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After months of piecemeal efforts to stabilize foundering US banks, the administration of President Obama is promising a comprehensive approach that a key economic adviser said will require Congress and the Federal Reserve to commit "several trillions of dollars" to repair the nation's financial system and economy.

Although he did not reveal details of the plan, Timothy Geithner, testifying at his Senate confirmation hearing for Treasury secretary, suggested it would include programs to shore up banks, address the housing crisis, and get credit flowing to consumers, small businesses, and students. Earlier, former Federal Reserve chairman Paul Volcker, who introduced Geithner at the hearing, warned that the government would have to "come to the rescue" to fix the financial system and ultimately, the economy.

"To put it starkly, we are in a serious recession with no end clearly in sight," Volcker said. "Over time, the hard fact is several trillions of dollars will be necessary to be committed in a combination of budgetary expenditures and various guarantee and insurance programs and extensions of credit by the Federal Reserve."

The prospect of more help for banks helped stock markets rebound yesterday from Tuesday's steep losses. The Dow Jones industrial average rose 279.01, or 3.5 percent, to 8,228.10. The technology-heavy Nasdaq Composite index rose 66.21, or 4.6 percent, to 1,507.07. The Standard & Poor's 500 index gained 35.02, or 4.35 percent, to 840.24.

Obama will address Congress within the next few weeks to detail the plan, which Geithner said will represent "fundamental reform" of the $700 billion financial rescue package approved in the fall. The Bush administration spent most of the first $350 billion by investing money directly in banks in exchange for ownership stakes. The new administration last week received congressional approval to release the remaining $350 billion.

Despite the injection of taxpayer money, the banking system continues to teeter. The original strategy behind the bailout called for the government to buy housing-related investments, such as securities backed by mortgage payments, that were creating huge losses at banks. When struggling homeowners stopped paying their mortgages, the value of the securities plunged, tying up the assets of banks and paralyzing their ability to offer loans.

But investors, fearful of more losses, are reluctant to invest in banks. Banks, in turn, have had to curtail lending to preserve capital they need to survive the downturn. The result: a credit crunch that is choking the economy.

The initial idea of the bailout was to take the troubled assets off the books, freeing banks to raise more capital and resume lending.

But after the bailout was approved, the economy began to deteriorate so rapidly that the Bush administration decided it didn't have time to set up a complex auction system to buy housing related assets. Instead, it pumped the money directly into the banks.

But even with that money, the capital position of many major banks has continued to worsen along with the economy. Accelerating job losses and rising unemployment have meant more defaults on home and consumer loans, and more losses for banks.

"The problem is more severe than had been thought," said Martin Baily, senior fellow at the Brookings Institution, a Washington think tank, and a former chairman of the Council of Economic Advisers under President Clinton. "And it's getting worse because of the recession."

Analysts said fixing the banking system will require new injections of taxpayer money, the purchase of troubled assets, and more than another $350 billion. Administration officials have floated the idea of creating a so-called bad bank that would buy and hold troubled assets.

In addition, they said, the federal government will have to use some of the bailout money to help struggling homeowners restructure and refinance mortgages to keep them out of foreclosures. Stabilizing the housing market ultimately will stabilize the values of assets tied to housing.

"You have to stop the decline in housing prices," said Allen Sinai, chief economist at Decision Economics, a Boston financial markets advisory firm. "The minute that happens, values of the assets will stop declining."

Yesterday, on a 260-to-166 vote, the House passed legislation that would require using $40 billion to $100 billion from the bailout fund to reduce mortgage foreclosures. In addition, the bill calls for restrictions on executive pay at financial institutions that receive the money.

Obama's economic team has said it would follow such provisions even without legislation.

Material from Globe wire services was used in this report. Robert Gavin can be reached at rgavin@globe.com.

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