What Happens Now to Plan to Buy Toxic Bank Debt?

Now that the focus of Treasury’s bailout plan has shifted to recapitalizing banks, there are renewed questions about what will ultimately happen with the original plan to buy troubled mortgage-backed assets.

After rejecting the idea of the government taking direct equity stakes, senior officials— including Treasury Secretary Henry Paulson and Fed chairman Ben Bernanke—are now pushing the plan as promising “more bang for the buck.”

The about-face—as well as the decision to spend at least $250 billion of the $700 billion bailout fund to buy preferred bank shares—has cast doubt about just how important the purchase of troubled assets will eventually prove to be.

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That doubt is heighten by the view of experts, such as Nouriel Roubini, a finance expert at New York University, who thinks the US banks are so weakened they will need at least $500 billion in direct capital as soon as possible.

Direct capital injection is also the approach—combined with even broader guarantees—being pursued by financial authorities around the world, led by Europe.

“What the US has done is basically play catch up, with regards to the capital injection and guarantee program,” says banking analyst Bert Ely. “I don’t think it [the asset purchase] was fundamentally flawed [but] I think it was oversold [as the only solution whereas] recapitalization is a fundamentally simpler and more straightforward process.”

Still, officials are pressing ahead with preparations for to buy or auction off the banking system’s toxic debts. On Tuesday, Bank of New York Mellon was appointed to manage the program.

Fed chairman Bernanke, speaking at the Economic Club of New York on Wednesday, insisted both parts of the rescue plan were still on track and are “highly complementary.”

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