Feb. 6 (Bloomberg) -- The Obama administration is considering subjecting banks to a new test to determine whether they have enough capital as part of the rescue plan to be unveiled by Treasury Secretary Timothy Geithner next week, people familiar with the matter said.

The Treasury may increase its stake in lenders that are judged short of capital, the people said on condition of anonymity. Should extra taxpayer funds result in a majority ownership by the government, officials would then decide whether to liquidate the institutions, place them into receivership or retire the companies’ assets over time, they said.

The proposals are part of what the Treasury calls a “comprehensive” effort to shore up confidence in the American financial system after more than $750 billion in credit losses. In a further move to revive lending, the Federal Reserve will likely increase its $200 billion program to finance education, car and credit-card loans, according to two people briefed on the deliberations. Details are still being discussed and could change.

Still on the table are efforts to deal with the toxic assets clogging banks’ balance sheets. The options include government guarantees and the creation of a so-called bad bank, possibly financed by the sale of debt backed by the Federal Deposit Insurance Corp.

“A lesson from past experience with banking crises around the globe is that the removal of bad assets from bank balance sheets, along with the injection of new capital, is needed to restore health to the banking system,” San Francisco Fed President Janet Yellen said in a speech today.

Monday Speech

Geithner will present his plan on Feb. 9 in a speech at the Treasury scheduled for 12:30 p.m. in Washington.

“They need to get credit flowing again,” said Kenneth Rogoff, a professor at Harvard University and a former chief economist at the International Monetary Fund. “To do that they need to clear the decks somehow. The financial system is just dead in the water.”

Efforts to breathe life back into the banking system have taken greater urgency as reports showed the recession -- already the worst since 1982 -- is deepening. The Labor Department said today that another 598,000 jobs were lost in January, driving the unemployment rate to 7.6 percent, the highest level in 17 years. As more people lose their jobs, more loans have soured and banks have become even more reluctant to lend.

Forcing Change

President Barack Obama has warned that some banks have yet to fully reflect losses on their assets, and stress tests may offer the government a way of forcing firms to reckon with the illiquid securities. The tests model what would happen to banks in different scenarios and gauge whether they have enough capital to survive.

Geithner has for years pushed lenders to be more aggressive in assessing the vulnerability to their capital and liquidity of their trading to unexpected crises.

“More rigorous and comprehensive stress testing of large shocks across multiple markets, geographic regions and business lines is vital, particularly for systemically important institutions,” Geithner said in an April 2005 speech, when he was the president of the New York Fed.

More recently, in responding to questions from lawmakers after his confirmation hearing last month at the Senate Finance Committee, he called for “more frequent and more focused forward-looking assessments of capital and liquidity adequacy under a range of possible scenarios.”

Congressional Criticism

The S&P 500 Financials Index is down almost 50 percent since the $700 billion Troubled Asset Relief Program was enacted Oct. 3. The first half of the TARP was dedicated to injecting capital into more than 300 financial firms and bailing out automakers.

Officials have for weeks talked about how to overhaul the four-month-old $700 billion financial-rescue program, which Congress has criticized for failing so far to restart lending to consumers and businesses.

One of the main sticking points has been how to value the assets that the government could insure or guarantee -- a challenge that helped force former Treasury Secretary Henry Paulson to abandon an earlier effort at doing so last year.

Still, addressing the deteriorating investments is critical to repair the financial system and allow lenders to begin extending credit again, economists say.

Yellen, who served as White House Council of Economic Advisers chairman in the Clinton administration, warned that “as long as hard-to-value, troubled assets clog their balance sheets, banks find it difficult to attract private capital and to focus on new lending.”

To contact the reporters on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net; Rebecca Christie in Washington at rchristie4@bloomberg.net.

Last Updated: February 6, 2009 20:47 EST