On Monday, the British government swooped in to boost its stake in troubled Royal Bank of Scotland to almost 70 percent and offered to insure banks against large-scale losses on risky assets in exchange for binding agreements to lend out more money.
It was the second major British bank bailout in three months. Shares of ailing RBS, parent of Providence, R.I.-based Citizens Financial Group., lost two-thirds of their value in Monday's trading. Shares of other European banks plunged as investors worried that one or more banks could be nationalized after RBS said last year's losses could reach $41.3 billion — the biggest ever for a British corporation.
Officials on both sides of the Atlantic have failed to contain the most severe credit crisis in decades, which has ravaged banks in places as diverse as Ireland, Iceland and Switzerland, along with the U.S. and Britain.
Now top officials in London, Washington and Brussels are scrambling to figure out how to stop the bleeding. They are trying to find the best way to prod banks into lending out more money, struggling for a solution 18 months after the most severe credit crisis in decades sent investors reeling.
U.S. officials are talking about establishing a new government-backed bank to remove bad loans and other toxic assets from banks' balance sheets, Treasury Secretary Henry Paulson said last week. In theory, with those assets gone, banks would be freer to make more loans.
Still, figuring out a successful strategy for how to unclog the credit markets is a vexing challenge for Obama when he takes office on Tuesday. Obama's top economic adviser, Larry Summers, said on CBS' "Face the Nation," Sunday that under the new administration, "the focus isn't going to be on the needs of banks. It's going to be on the needs of the economy for credit."
Obama will have a "strong message for the bankers," adviser David Axelrod said Sunday on ABC's "This Week." "We want to see credit flowing again. We don't want them to sit on any money that they get from taxpayers."
While the British government moves closer to a full takeover of that country's banking system, Americans are more leery of such intervention, and that's likely to continue even with Democrats in charge of the White House and Capitol Hill, analysts say.
"We're much less comfortable with nationalization," said Simon Johnson, former chief economist to the International Monetary Fund and a professor at the Massachusetts Institute of Technology's Sloan School of Management. "We're generally more skeptical of the ability to run things better than the private sector."
The U.S. government has so far provided $192.3 billion to 257 large and small financial institutions in 42 states and Puerto Rico in a financial bailout program that has proven extremely unpopular with the public. Now the government is facing calls to use its power to fire executives at banks that receive government aid.
"What you really need is ... a change of management in these banks," Johnson said. "The banks have been run by incompetent bunglers."
There is a precedent for the idea of a government-run "bad bank" that would take toxic assets off the books of banks and thus make it easier for them to loan new money: the Resolution Trust Corp., created in 1989 to dispose the assets of nearly a thousand failed savings and loans.
One key question, though, is how much the new bank would pay for distressed assets. Buying assets at too high a price would reward them for taking too much risk. Buying them at too low a price would mean banks will have less money to lend out in the future, said Stephen Lewis, chief economist at Monument Securities in London.
Plus, with the government acquiring billions in potentially bad loans, "it would leave the taxpayer fully exposed to any future losses," Lewis said.
American officials are considering other ideas to cope with the credit crisis, which started in August 2007 and has proven far more severe than all but the most pessimistic analysts had expected. Last week, Federal Reserve Chairman Ben Bernanke offered a series of options, including guarantees under which the government would agree to absorb part of the future losses on portfolios of rotten assets, presumably in exchange for warrants or some other form of compensation.
However, some question whether the government should be pressing banks to lend more, calling the tightening of lending standards an inevitable reaction to a period in which they were far too loose.
"Banks are in the business of lending, but they've got to lend prudently," said Bert Ely, a banking industry consultant in Alexandria, Va. With the economy contracting, many consumers are inclined to reduce their outstanding debt, Ely said, and don't want to borrow.
The current U.S. rescue program has come under heavy criticism from lawmakers unhappy that the Bush administration provided billions of dollars to banks to shore up their finances, but did not impose enough restrictions to make sure they would increase their lending.
Many lawmakers are pushing the incoming Obama administration to devote more of the money to halting a tidal wave of mortgage foreclosures, and to impose more limits on the compensation of top executives working at the banks receiving the money. The incoming administration has pledged to revamp the rescue program to address objections from lawmakers.
Last week, new cracks appeared among the country's two largest banks.
Citigroup Inc. last Friday reported a $8.29 billion loss in the fourth quarter and announced it was splitting itself in two. Bank of America reported a $2.39 billion fourth-quarter loss, hours after ironing out a deal for a fresh $20 billion government lifeline to digest troubled brokerage Merrill Lynch.