The big bang announcement by US Treasury planned for next week is likely to have three key economic elements: moves to clean up the banking system, moves to restore the flow of credit in securitized financial markets, and moves to reduce home foreclosures.

The exact shape of the banking sector clean-up plan has still not been finalized. But it is likely to involve elements of both a “bad-bank” solution and insurance-style guarantees on pools of problem assets that remain on bank balance sheets reports the Financial Times.

Assuming this approach is approved, the bad bank would be capitalized with equity from the Treasury’s troubled asset relief program (Tarp) and take on debt, possibly guaranteed by the Federal Deposit Insurance Corporation (FDIC), with some Washington insiders estimating it would have about $1,000bn purchasing power.

It would acquire securities that had already been heavily marked down by financial institutions, probably using a valuation model rather than an auction-based process to determine pricing.

The US authorities may al­so provide insurance-style guarantees on pools of problem assets that remain on bank balance sheets. This approach is seen by some as better suited to assets that have not yet been heavily written down and for loan portfolios that are in the early stages of deterioration. The bank clean-up is likely to be paired with a revamped recapitalisation scheme, involving a thorough overhaul of Tarp.

Additional restrictions on executive pay and excessive dividends are likely, in an effort to avoid leakage of public capital to employees and shareholders, as well as to shore up public support for the unpopular process.

Treasury is also likely to announce a separate battery of moves designed to revitalise the securitised markets for credit. This could involve a scaling up of an existing Treasury-Federal Reserve joint venture called the term asset-backed securities loan facility, which provides low cost loans for investors willing to buy new securitised consumer loans.

This approach may also be used to try to restore the flow of credit for commercial mortgage-backed securities, jumbo mortgage-backed securities and municipal bonds. It is possible that the Treasury could offer some credit guarantees in a further effort to boost credit flows, though some policymakers are hesitant.

The foreclosure relief element of the package is likely to commit tens of billions of dollars to support schemes that aim to lower monthly mortgage payments to no more than 38 per cent of income, though it will probably also include backing for loan principal reductions in cases where the mortgage is worth a lot more than the value of a home.

Read more here: A big bang plan to clean up US banking system