Page last updated at 21:17 GMT, Tuesday, 10 February 2009

Q&A: US bank bail-out revamp

Timothy Geithner, file pic from 21 January 2009
Geithner has been involved in US efforts to prop up financial institutions

US Treasury Secretary Timothy Geithner has announced major changes to the government's programme for bailing out troubled banks.

The measures include a partnership with the private sector to purchase bad or "toxic" assets, in order to get them off the banks' balance sheets.

The scheme is a revision of the $700bn Troubled Assets Relief Programme (Tarp) which was set up by the Bush administration, of which $350bn has been spent already.

How will this partnership work?

The idea is to set up a public-private investment fund of $500bn, which could be expanded to $1 trillion.

This will allow ordinary banks to offload mortgage-backed securities and other assets that have been rendered near-worthless by the sub-prime mortgage crisis and the credit crunch.

This bank will be essentially a private entity, but it will be seeded with government money.

Mr Geithner's revamp marks a return to the original bail-out strategy proposed by his predecessor, Henry Paulson.

The $700bn Tarp fund was originally intended for buying up banks' toxic mortgage debts, but was then used instead to buy shares in banks, in order to help boost their balance sheets.

So why the change of heart?

It's partly political. President Barack Obama's administration wants to distance itself from the perceived mistakes of the Bush administration's approach to the crisis.

The "mission creep" that took place under Mr Paulson left Tarp tarnished and in need of a make-over.

But it's also an acknowledgement that trust cannot return to the money markets until financial institutions are purged of their worst liabilities.

Many bankers have given the "bad bank" idea a guarded welcome, given that the alternative is to let the federal government take a direct stake in their institutions.

But others feel that the bad assets in question are worth holding on to. After all, they have already been written down on banks' balance sheets and may eventually go up in value when the markets recover.

What else does Mr Geithner have in mind?

The government wants tighter scrutiny of what is happening to its bail-out money.

Earlier this month, Mr Obama announced a $500,000 (£355,000) limit on executive pay at US firms that need substantial fresh government aid.

Mr Geithner wants to add further terms and conditions, including a requirement for the companies that have accepted the aid to report on how it is being spent.

However, he reportedly faced down pressure from other Obama advisers for even stricter government controls.

The administration also wants to learn lessons from last year's collapse of Lehman Brothers investment bank and the bail-out of insurance giant AIG.

In both cases, there was no single federal institution that could step in and take charge.

The Federal Deposit Insurance Corporation (FDIC), which currently oversees retail banks, could be given the power to do this, although this is likely to require a change in the law.

So much for Wall Street. Is there any help for ordinary people?

Well, there are some proposals that might help take the heat off hard-pressed homeowners trying to pay back those sub-prime mortgages.

Mr Geithner wants to make it easier to work out the value of a home threatened by foreclosure, so that lenders can decide how to modify the terms of the deal.

Mortgage giants Fannie Mae and Freddie Mac would apply new national standards of loan modification, while other mortgage lenders would get financial incentives to reduce interest rates to cash-strapped customers.

This could cost an additional $50bn to $100bn.

The government also wants to expand consumer credit, building on an existing scheme called the Term Asset-Backed Securities Loan Facility (Talf).

This would make it easier for people to borrow money to buy cars or for student loans, as well as provide new financing for such things as commercial property loans.

It would be run by the US central bank, the Federal Reserve, with support from the Treasury.

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