Bailout: Getting Banks to Bite 3

Fraud Is Another Risk

Bair emphasized that her agency's risk would be low. First, the FDIC's loans would be separate from its flagship deposit-insurance program, and the fees the agency will charge for its loan guarantees could even bolster its finances. Meantime, she noted that any given pool of assets would have to lose at least 15%—the amount put up by the Treasury and private investors—before the FDIC would be at risk of having to make good on its guarantee.

"I actually think the credit risks are pretty good for us," she said, saying several times that she expects the arrangement "to make money" for the FDIC.

Kyle argues that the relatively modest private-sector participation carries another risk: fraud. A large increase in the purchase price for a pool of assets will only cost the investors a small amount—an additional $100 million bid for a pool could cost the investors just $7 million, for example. And, because investors control the bidding, they could collude with the bank selling the assets to inflate prices and be reimbursed by the bank reaping the gains, Kyle said.

Pimco's Bill Gross Hails Plan

Treasury officials are aware of the risk, and are working with the federal bailout's Special Inspector General's office and consultants to prevent fraud, a person familiar with the matter said.

Institutional investors, however, were generally supportive of the plan. Some of them hailed it as the kind of clear, bold step that could mark a turning point in the financial crisis. Bill Gross, the high-profile bond fund manager at Pacific Investment Management Co., or Pimco, told Reuters that "this is perhaps the first win-win-win policy to be put on the table and it should be welcomed enthusiastically."

But a serious hitch could be the white-hot anger that taxpayers and their congressional representatives feel over earlier bailouts, warned Stephen Auth, chief investment officer for global equity at Federated Investors (FII). Last week, outrage boiled over regarding bonuses paid out by American International Group (AIG), the huge insurance company that has received billions of taxpayer dollars to avoid collapse. That was capped by the House of Representatives passing a 90% tax on many bonuses paid by big financial firms receiving federal aid. The possibility of becoming a similar target could spook companies that otherwise would be willing to invest alongside the government, or sell toxic assets under the new program.

A Lot Riding on the Senate

Although Treasury and FDIC officials have said the range of executive-comp rules applied to companies receiving bailout funds wouldn't be applied to participants in the new program, Auth said investors might not trust those assurances. Much depends on whether the Senate adopts the House bonus tax, or tones it down significantly, he said.

"If they put that thing through the way it's drafted now, you can forget Geithner's plan," Auth said.

Francis is a writer in BusinessWeek's Washington bureau. Sasseen is Washington bureau chief for BusinessWeek.