FDIC shelves toxic loan plan

The agency delays the launch of a program to get bad loans off banks' books, citing their capital-raising success.

By Colin Barr, senior writer

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FDIC chief Sheila Bair has had to do an about-face on a plan to take bad loans off banks' books.

NEW YORK (Fortune) -- Regulators shelved a controversial plan that aimed to cleanse banks' balance sheets of toxic assets.

The Federal Deposit Insurance Corp. said Wednesday it has postponed the initial sale of bank assets under its Legacy Loans Program, or LLP. The FDIC said it wasn't canceling the program but would put it under study for revival in a different form.

The plan, which was to offer low-cost federal financing to private investors in troubled bank assets, had been expected to begin with a trial sale this month.

The loan program was unveiled in March as part of the Obama administration's effort to restore investor confidence in the financial system. At the time, officials said removing bad assets from banks was the key to restarting the financial markets and putting the economy on track to recover.

But since then, policymakers led by Treasury Secretary Tim Geithner and FDIC chairman Sheila Bair have put the nation's 19 largest banks through stress tests. The tests came in generally better than observers had expected, and big institutions have been able to raise some $85 billion in investor funds.

Shares of banks ranging from money-center giants Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500) to regional banks Fifth Third (FITB, Fortune 500) and KeyCorp (KEY, Fortune 500) have rallied.

Other big banks, including Goldman Sachs (GS, Fortune 500) and JPMorgan Chase (JPM, Fortune 500), have laid plans to repay money they got last fall under Treasury's Troubled Asset Relief Program. Regulators are expected to let some banks begin paying back those funds next week.

The banks' capital-raising success, coming just months after a robust debate in Washington and on Wall Street about whether distressed giant banks would have to be taken over by the government, has reduced banks' incentive to sell assets into the legacy loans program, regulators said.

"Banks have been able to raise capital without having to sell bad assets through the LLP, which reflects renewed investor confidence in our banking system," Bair said in a statement Wednesday. "As a consequence, banks and their supervisors will take additional time to assess the magnitude and timing of troubled assets sales as part of our larger efforts to strengthen the banking sector."

But the industry's success in refilling its coffers isn't the only thing that doomed the legacy loans plan and the broader Public-Private Investment Program (PPIP).

The Boxer rebellion?

Critics warned that PPIP amounted to a multibillion-dollar handout to banking industry insiders who had already profited at the expense of the general public during the credit bubble earlier this decade.

In addition, investors and bankers cowered at the thought of submitting to deepening and often capricious government involvement in the private sector.

And then Congress got into the act, making it all much worse.

Bair said two weeks ago at a press briefing that the legacy loan start date was running late because Treasury was reworking the rules to implement a recently enacted amendment by Sens. Barbara Boxer, D-Calif., and John Ensign, R-Nev. The amendment aims to prevent collusion or conflicts of interest in the legacy loan program.

The Boxer-Ensign amendment ultimately may have caused some big players to back away from PPIP - illustrating what Hal Reichwald, a partner at law firm Manatt, Phelps & Phillips in Los Angeles, calls "the toxic combination of policy and politics."

The next step, Reichwald suggests, is for regulators to embrace the possibilities of reconstituting troubled banks with the aid of private equity investors. He points to the recent FDIC seizure and sale of Florida's BankUnited -- as well as the likely use of so-called good bank/bad bank structures that separate troubled assets from banks.

Along those lines, the FDIC said Wednesday it will test the legacy loans funding structure in a sale next month of receivership assets -- the remains of a failed bank.

"The current situation behooves all those who would be players in the distressed asset market to begin to think creatively," Reichwald said in a recent note to clients, "because notwithstanding the government's apparent change of heart the opportunities are still there."

CNNMoney.com senior writer Jennifer Liberto contributed to this report. To top of page

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