Treasury's Rescue Plan Hits Technical Snag

Banking regulators are working today to resolve accounting roadblocks that would hold up the government's plan to revive financial markets by investing $250 billion in the nation's banks.

The problem is this: Under existing rules, banks cannot count the Treasury Department's investment as part of their core capital, the foundation of money that supports a bank's operations. The very goal of the plan was to buttress those foundations, which have been eroded by recent losses, undermining the stability of the banks.

The Treasury's initial investment in nine of the largest banks cannot go forward until the accounting issues are resolved, people familiar with the matter said. Regulators are now working to figure out how to change existing rules to accommodate the program, the latest in a string of ad hoc measures to address the financial crisis.

Yesterday, the Federal Reserve issued a rule, effective today, that suspends its long-standing objections to counting such an investment toward core capital. But other regulators have yet to act.

A Treasury spokeswoman declined to comment on what she described as a regulatory matter. The Treasury has not yet made the investments but said it could do so within days.

Treasury announced Tuesday it would invest $125 billion in the nine banks and an additional $125 billion in the rest of the banking industry. In exchange, the banks would give the government an unusual kind of stock called perpetual preferred shares. Holders of these shares are excluded from shareholder votes on company business, but they receive annual interest payments and their shares have priority in the event of a bankruptcy.

In general, money raised by selling shares of stock is a basic component of core capital. Under existing rules, however, banks cannot count these perpetual preferred shares as part of their core capital. There are several federal agencies that oversee different parts of the banking industry; the exact rules governing core capital vary by agency.

In issuing its rule, the Fed changed its rules to allow Treasury's investment to count as core capital. The Fed oversees bank holding companies -- the parent companies such as J.P. Morgan Chase that own banks such as Chase.

Robert Garsson, a spokesman for the Office of the Comptroller of the Currency, the regulatory agency that oversees the subsidiary banks, said this afternoon the agency had determined that banks can count the investment as core capital.

"Any preferred shares issued to Treasury under this program will count," he said.

Treasury plans to invest in a wide range of banks overseen by other agencies, including the Office of Thrift Supervision, the Federal Deposit Insurance Corp. and state banking regulators. All have their own capital standards and it remained unclear early this afternoon how many of those standards might need to be adjusted. The Office of Thrift Supervision, for one, said it does not currently allow such investments to be counted as core capital. A spokeswoman said the agency is reviewing the issue.

The Fed's previous rules excluded from core capital those shares that pay a stepped interest rate, meaning that the yield on the shares increases after a fixed period of time. The shares issued to Treasury would pay 5 percent for five years and 9 percent thereafter. The Fed's previous rules also limited the portion of a bank's capital that can come from preferred shares.

Banking regulators have traditionally been concerned that the increase in interest payments made such preferred shares a less stable source of capital, because it increases the chances that a bank will decide to repay the shareholder's investment and eliminate the shares.

In setting aside its concerns, the Fed noted that the Treasury's plan was designed "to help achieve a fundamental public policy objective in the United States."