Bailout gets hit from all sides

Critics across a broad ideological spectrum are ramping up their attacks on the Treasury Department’s $700-billion banking bailout, saying it is now doing more damage to credit markets than good.

Lending is flat, investors are fleeing bank stocks, and the huge investment by the government into troubled banks has plummeted in value by more than $100 billion, according to some recent studies.

In congressional hearings, lawmakers have repeatedly asked whether the rescue program threatens the solvency of the federal government. Obama administration officials dismiss the risk.

Defenders of the program say that despite problems, the bailout prevented a financial-system meltdown in the fall, and that Obama administration policies have not had time to have an impact.

None of the critics of the government’s Troubled Asset Relief Program has offered a better alternative, said a senior Treasury Department official, who did not want to be identified because he does not speak publicly on the issue.

But critics contend that what was originally proposed as an overwhelming gesture of government resolve to get banks on their feet now seems like an intravenous drip, barely sustaining the giant institutions that account for the majority of U.S. bank assets. As time goes on, the problems appear again to be deepening.

“Some of these banks are walking dead and should be closed,” said Sen. Richard C. Shelby of Alabama, a 20-year veteran of the Senate Banking Committee and its senior Republican. “We are propping up financial institutions that are insolvent and have already failed. The government has made a political decision to keep them going at the taxpayers’ expense.”

At the other end of the political spectrum, the AFL-CIO Executive Council voted unanimously last week to urge President Obama to nationalize problem banks as a way to stimulate and stabilize the financial system.

“Every day we delay is another day workers in this country feel the pain of a stagnant economy,” said Richard L. Trumka, secretary-treasurer of the labor organization, a powerful influence on the Democratic-controlled White House and Congress.

Even some banks are furious over how they say the government has bungled describing the program to the public, allowing investments in weak banks to stigmatize healthy banks that took government funding.

The crux of the issue is whether the Obama administration can financially engineer its way out of the crisis. It has introduced four programs that will be funded by what remains of the bailout, aimed at further shoring up banks, helping homeowners, resuscitating non-bank lending and clearing remaining bad debts.

A key to the strategy, first for President George W. Bush and now Obama, has been to keep the government from taking over troubled banks -- an option that would wipe out existing investors.

That could pose a variety of risks. Confidence in the banking system could dissolve, depositors might make a run on banks, the federal deposit insurance fund could be exhausted, and an economy-wide lending freeze could deepen. Shareholders of healthy bank chains might be the first to panic if the federal government seized a large, weak bank.

“If we did that to Bank A, Bank B shareholders would say, ‘We may be next,’ ” the Treasury official said. “And so they start selling their shares and running for cover. They could precipitate the crisis of confidence among their lenders and their depositors that we are trying to avoid.”

“It is very easy to say, ‘Let’s wipe out the shareholders,’ but you have to understand what that will translate to,” the officials said.

Treasury Secretary Timothy F. Geithner, speaking in a series of hearings, interviews and speeches, has attempted to tamp down speculation about bank nationalization or seizure in the last two weeks, saying it represents the wrong strategy for the country.

But critics of the Treasury’s approach see a different doomsday scenario -- a slow bleeding death.

“Time is clearly against us,” said economist Joseph Stiglitz, Columbia University professor and Nobel Prize winner. “Confidence is not irrelevant, but if you don’t do the diagnosis right, then you undermine confidence. TARP not only has failed to address the underlying problems, but its failure has contributed to making things worse.”

Elizabeth Warren, Harvard University law professor and chair of a special congressional oversight panel for the banking bailout, suggests the program may exhaust the resources of the federal government.

“So far, the TARP money has been aimed toward protecting the banks’ investors and debt holders,” Warren said. “The problems in these banks run deep, and taxpayer support cannot be unlimited. There is a real question whether Treasury has come to terms with that problem.”

Economic indicators have continued to signal grave concerns about the financial system. On Monday, the Wall Street Journal reported that credit markets are again seizing up, indicated by capital continuing to flee from the private market to Treasury bonds.

Bank stocks remain severely depressed, with troubled Citigroup Inc. selling for $1.05 per share, down from a 52-week high of about $27.

So far, allegations of outright fraud have not hit the program, but that too is likely. When Congress authorized TARP under the Emergency Economic Stabilization Act, it created a special office of inspector general to oversee the program.

Neil Barofsky, the special inspector general, said that fraud in the program could reach into the tens of billions of dollars, based on the performance of past government programs.

Only weeks after starting to examine TARP payments, Barofsky said in an interview that he has opened several criminal probes.

In addition to Barofsky and Warren’s offices, the Government Accountability Office, the investigative arm of Congress, is also empowered to oversee TARP. It is still struggling to assess the program’s impact, given the lack of reporting that was set up under the original legislation.

A Treasury survey of the top 20 banks recently suggested that their lending was more or less flat after they received TARP funds.

“It doesn’t really answer the question of whether it prevented the financial system from going down the drain,” said Thomas McCool, a GAO banking expert.

“You have the Treasury saying the condition of the banks would have been much worse, and you have others saying, ‘Show me the evidence that this had impact.’ ”

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ralph.vartabedian@latimes.com

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Tom Hamburger in our Washington bureau contributed to this report.