How Will Paulson Pick Bank Winners and Losers?

That question lies at the heart of how the remaining billions in the bank-rescue fund will be doled out

By Jane Sasseen

U.S. Treasury Secretary Henry Paulson and other regulators went a bit further toward spelling out how troubled banks will go about securing a capital infusion from the Treasury's $250 billion rescue fund. However, at a press conference held on Monday, Oct. 20, Paulson continued to be mum on a core question: How exactly will regulators decide who does, or does not, get the money?

Banking industry sources say the government has little choice but to pick winners and losers among the struggling banks, now that the Treasury has spread half of its first batch of money—$125 billion—among nine large institutions. While those that are currently solvent but lack liquidity will likely get funding, others that are essentially insolvent will not, at least not if they remain on their own. "The key is the bank has to be viable," says Bob Litan, a senior fellow and specialist on financial issues at the Brookings Institution. "Regulators have got to make sure that if they put money in, the bank will survive."

As to how they'll do that, exactly, regulators refuse to be specific. Nor will they release the names of any banks that apply and either get turned down by Treasury or withdraw their application—information that, if it were to become public, would surely lead investors to flee a bank's stock. "Not releasing the criteria or the names of institutions who don't receive funds makes sense, to prevent investors and depositors from drawing negative inferences and acting on incomplete information," says Scott Talbott, a senior vice-president of the Financial Services Roundtable.

Taxpayer Losses Not Expected

Officials made clear Monday that not every bank that applies will necessarily get funding. In a brief speech, Paulson also stressed that the money spent will not lead to taxpayer losses. "This is an investment, not an expenditure, and there is no reason to expect this program will cost taxpayers anything," he said.

Paulson said the Treasury has already received "indications of interest from a broad group of banks of all sizes." And he made clear that the money won't be doled out on a first-come, first-serve basis. "Sufficient capital has been allocated so that all qualifying banks can participate," he added.

Instead, the Treasury has worked with the primary regulators of the banking industry—the Federal Deposit Insurance Corp., the Federal Reserve, the Office of Thrift Supervision, and the Office of the Comptroller of the Currency—to come up with a uniform application and a standardized evaluation process for all the institutions who want access to new funds. The banks and other institutions will be required to apply by Nov. 14; various regulators will then make a recommendation based on standardized criteria. The final decision, however, will lie with Treasury.

Mergers or Sales Possible

Banking regulators insist they have plenty of insight into the institutions' financial state. "Obviously we're very familiar" with the health of the institutions we oversee, says one senior regulator. He argues that the decisions will be based on our "knowledge of management and the strength of individual business plans, as well as the known strengths and weaknesses" of each institution.

Other things may factor into their decisions as well. If a troubled institution may no longer be able to last on its own, banking regulators are more likely to push it toward a merger or a sale, as they've done with Bear Stearns and Wachovia (WB). And in such cases—or where an institution is able to find a merger partner on its own—the new joint enterprise could get Treasury funds. Weak firms that can nevertheless do "a concurrent capital rise" will also have a better shot at getting funding, adds another official.