WASHINGTON — Though it has already moved in an ad-hoc fashion to help backstop failing financial companies, the Treasury Department is working on a formal plan designed to allow it to rescue systemically important institutions.
Though the agency acknowledged the existence of the plan last week, little is known about it.
"The Treasury Department is currently developing a third program to potentially provide direct assistance to certain failing firms on terms negotiated on a case-by-case basis," the agency said in a press release announcing restrictions on executive compensation.
The compensation restrictions would affect banks that sell troubled assets to a new government facility, receive an equity investment from Treasury, or benefit from its program for "systemically significant failing institutions."
Observers said that the program may be an effort to standardize what the government has already done in the cases of Bear Stearns, American International Group, and others. It may also be a way for the Treasury to take over a role that had fallen to the Federal Reserve, which has taken the lead on loans to failing companies.
"There were certainly people who felt that the Fed is at the broad edge of its statutory powers with some of the steps it has been taking," said Douglas Landy, a banking partner at Allen & Overy LLP and a former lawyer for the Federal Reserve Bank of New York. "On a longer-term basis, this just isn't going to work in such a haphazard function."
Legal observers agreed that the Treasury can respond to an individual institution's needs under the massive rescue bill passed this month. The bill's core was a program to buy companies' illiquid mortgage-related assets, but the law also lets the Treasury use "any other financial instrument" that it believes will help the markets.
"They built in a lot of flexibility, and for good measure," said Kip Weissman, a partner at Luse Gorman Pomerenk & Schick PC.
He said a more formal statement on when the government will bail out companies could be helpful in deflecting some of the criticism that has arisen over certain deals. It may also help clarify circumstances under which the government would not step in, as with Lehman Brothers, which was allowed to fail.
"If you go down the road for more customization, which I think you need to do in larger cases, you still want to have a statement of principles out there to avoid a perception of sweetheart deals, especially in this political environment," Mr. Weissman said.
Last March the Fed stepped in with financing to facilitate Bear Stearns' sale to JPMorgan Chase & Co. Citing its existing lending authority, the Fed last month made an emergency $85 billion loan to AIG to keep it operating.
But those rescues were considered improvisations of sorts, carried out without a set of principles on saving individual institutions as the clock runs out. Observers said the Treasury could use its new authority to lay out a roadmap for such bailouts. "They're saying, 'This is the framework we will be using so that we can do this consistently,' " said Lawrence Kaplan of Paul, Hastings, Janofsky & Walker LLP and a former lawyer at the Office of Thrift Supervision.
A new systemic program would need to consider potential overlaps with the existing assistance program for depository institutions. By law, the Federal Deposit Insurance Corp. can help an open bank or thrift if its failure poses a systemic risk but must get concurrence from the administration and from the Fed.
The FDIC used that authority for the first time in its history last month when it backed a bid by Citigroup Inc. for the ailing Wachovia Corp. (The bid ultimately failed when Wells Fargo & Co. made a more attractive offer to Wachovia shareholders.)
But observers said a Treasury policy for direct assistance could backstop a wider swath of institutions with systemic importance, including hedge funds, investment banks, insurers, and automobile companies that are not covered by the FDIC.
"We would hope that the program would be applied to any institution with a significant role in the economy where … assistance would help restore liquidity and aid the economy … , and that could include insurance companies and automakers," said Scott Talbott, a senior vice president at the Financial Services Roundtable.