Feb. 6 (Bloomberg) -- Treasury Secretary Timothy Geithner must use his Feb. 9 speech to lure private investment to U.S. banks or risk an accelerating flight of capital that would result in creeping nationalization, analysts and investors said.

His address, followed by President Barack Obama’s first prime-time news conference, may be his best chance at bolstering confidence in lenders and getting credit flowing to an economy mired in its worst slump in a quarter century.

“If they don’t get it right in the next couple of months, they are locked into a failed policy,” says Ross Levine, an economist at Brown University in Providence, Rhode Island, who has written two books on bank regulation. “The implications now are huge.”

Spooked by the possibility of forced writedowns and dilutive government stake purchases, and by the deepening recession, the Standard and Poor’s 500 Banks Index is down 43 percent since the start of last month. Bank of America Corp. yesterday touched its lowest level since 1984.

Geithner’s steps are likely to involve guarantees against losses on toxic assets, some effort to remove them from balance sheets and further capital injections, people familiar with the matter have said. The risk is that the effort proves too small or too costly to common stockholders to bring private capital back.

Government Dependence

More than 85 percent of the total of about $305 billion of capital raised by U.S. financial companies since the end of September has come from the government, with most of the remainder coming from sales of stakes in other banks.

“You are not going to restore credit to America without restoring private capital,” House Financial Services Committee Chairman Barney Frank told reporters this week. He warned against sending a “mixed message” to banks that they must both step up lending and buttress their safety and soundness.

Geithner will deliver a speech on Feb. 9 outlining the financial-recovery plan, ahead of an 8 p.m. Obama news conference, according to a Treasury aide. Geithner said at the White House this week that “we will have to do more, substantially more, to fix this crisis.”

Part of the sell-off in bank shares has been caused by worst-case estimates on the prices a government-run bad bank may set for illiquid securities. Researchers call it “burn-down” capital analysis -- calculating how much common equity will be destroyed if the bank were forced to take an immediate markdown on all assets rather than hold them until the securities mature.

‘Burn Down’ Analysis

Shares of Regions Financial Corp., SunTrust Banks Inc. and Fifth Third Bancorp have all been affected by burn-down analysis, said Kevin Fitzsimmons, a managing director at Sandler O’Neill & Partners LP in New York. The stocks trade at fractions of the most-recent estimates of tangible book value, meaning investors are jumping ahead of quarterly earnings reports and marking down the value of the assets now.

Regions Financial trades at 0.27 times its tangible book value per share at the end of last year of $10.59, and Fifth Third is at 0.19 times the year-end value, according to Sandler O’Neill calculations.

“The thinking is if they had to burn down and mark this balance sheet to market, they may end up needing to raise additional capital,” Fitzsimmons said. Because the government is the primary source of capital and “benefiting common shareholders isn’t one of their top priorities, it makes it dangerous to invest in these stocks right now.”

Government Stakes

The Treasury has invested more than $200 billion in more than 360 companies so far. The stakes are senior to those of common shareholders, and include conditions such as seeking officials’ approval for stock buybacks or a dividend increase. Obama also set new limits on senior executives’ pay for firms getting “exceptional” aid from now on.

Banks that have taken “extraordinary sums of money from the government are no longer free-market enterprises; they are mixed enterprises and that deserves a lower stock multiple than has historically been the case,” said Steven Einhorn, a partner at Omega Advisors Inc. in New York, which manages $3 billion. “If the government is going to protect your downside, they are going to constrain your upside.”

The focus of Geithner’s plan is likely to be guarantees of illiquid assets that remain on banks’ balance sheets, emulating deals done with Citigroup Inc. and Bank of America. Both rescues failed to reassure private investors. Citigroup’s shares are down 41 percent since the November announcement and Bank of America shares are down 32 percent since its January deal.

Partial Guarantees

“You do not want to go in and just guarantee assets for part of the bank’s balance sheet and leave the rest of the bank operating and yet it is still not in real good shape,” said former Fed Governor Frederic Mishkin.

Mishkin, now a Columbia Business School professor in New York, said the assets should be written down and removed from the bank, at the expense of shareholders if necessary, and then sold to investors. “It is absolutely imperative that we get this right in terms of getting the financial system started again.”

“The time the Obama administration has to get this right is really, really small,” said Joel Conn, president of Lakeshore Capital Inc., which manages about $100 million in Birmingham, Alabama. “It is very difficult to buy financial stocks because you don’t know what the ultimate losses are going to be, nor do you know where in the capital structure you would have some relative safety based on where the government would come in.”

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net

Last Updated: February 6, 2009 00:01 EST