Administration Wants Credit Flowing Again

The financial system may be getting a little better. For example, mortgage rates are lower. But many banks are still on the verge of collapse, and they are not lending enough. So the Obama administration is expected to move quickly to intervene, trying to get more money flowing to businesses and average people.

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RENEE MONTAGNE, host:

If Timothy Geithner is confirmed, he'll face one huge and immediate challenge: the credit markets. A few months ago, those markets were frozen. Now, there's a bit of a thaw. For example, mortgage rates have moved lower, but many banks are still on the verge of collapse and doing very little lending. NPR's Chris Arnold details the problems facing the new administration.

CHRIS ARNOLD: Despite all the government's efforts to prop up the banking system, a lot of banks around the country can't escape this basic problem: They've got a bunch of toxic assets on their books, some tied to bad home loans, and the losses keep getting worse and dragging the banks down. Citigroup, Bank of America and others continue to lose billions.

Dr. ALBERT KYLE (Finance, University of Chicago): This is, I think, the biggest issue in financial stability that economists and finance professors like myself are thinking about.

ARNOLD: Pete Kyle is a finance professor at the University of Maryland.

Dr. KYLE: The market is still wondering, how much larger are these losses going to be? And it looks like hundreds and hundreds of billions of dollars of losses still remain to be taken by the banking system.

ARNOLD: That's a really big problem. Many banks were already crippled by losses on bad home loans even before the recession hit, and now there's more credit-card debt going bad, business loans to companies that are going under, and the worsening recession is snowballing all of these losses. That's forcing banks to pull back on their lending, especially to people or businesses without perfect credit, and that continues to hurt the economy. At a Senate hearing yesterday, former Federal Reserve chairman Paul Volcker summed it up this way.

(Soundbite of congressional hearing, January 21, 2009)

Mr. PAUL VOLCKER (Former Chairman, U.S. Federal Reserve): To put it starkly, we are in a serious recession with no end clearly in sight. The financial system is broken. It's a serious obstacle to recovery. There's no escape from the imperative need for the federal government to come to the rescue.

ARNOLD: Volcker thinks that complex rescue of the credit markets will involve several trillion dollars of government guarantees, loans and investments. Some analysts think the government is going to have to step in and inject a lot more government money into the major banks. Pete Kyle.

Dr. KYLE: I think the stage is set for what some people are going to call nationalization of the big banks.

ARNOLD: That prospect has hammered back stock prices over the past couple of weeks. Though shares regained some ground yesterday, investors don't know what's coming next. One possibility is that the new administration might help the struggling banks to get those bad assets off of their books so they can recover and start lending to more people again.

Senator JOHN KERRY (Democrat, Massachusetts): There're too many zombie banks out there.

ARNOLD: Senator John Kerry yesterday said too many banks are like the walking dead, and just pumping more money into them hasn't been working.

Sen. KERRY: We're propping up fundamentally insolvent institutions. And unless those institutions clear their books of those toxic assets, we're simply going to compound this crisis.

ARNOLD: There are a few ways to do that. One is for the government to officially nationalize and take over the banks, but that's not very likely. Another option, a bank's assets could be split up into a good bank and a bad bank, so the good bank can raise money for shareholders and get healthy, and the government could help manage or buy up the toxic assets from a lot of banks, perhaps managing all of them in one massive bad bank, full of bad loans and securities. Pete Kyle says economists like him have never seen anything like this before.

Dr. KYLE: The scale of the bad assets is simply breathtaking. We are looking at bailouts that will dwarf the S&L crisis of the 1980s.

ARNOLD: Kyle warns that the government could take a bath on all this if it's done the wrong way, and even if it's done right...

Dr. KYLE: It's going to be very expensive for taxpayers. It's going to require hundreds of billions of dollars more, maybe trillions. And this is going to limit the ability of the government to do other good things going forward.

ARNOLD: Like fix the health-care system. That's why, Kyle says, as the government puts the credit markets back together again, he wants to see tough new regulations put in place to stop this from happening again. Chris Arnold, NPR News.

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