The Obama administration on Monday unveiled details of a toxic asset rescue plan, taking a bold step to cleanse from bank balance sheets bad assets that have frozen up lending and fueled the recession.
The Treasury said the three-part program will provide financing through the Federal Reserve and the Federal Deposit Insurance Corp.(FDIC) to help public-private investment partnerships buy up to 1 trillion dollars in distressed loans and securities.
Three-part program
At the core of the financing package will be 75 billion to 100 billion dollars in capital from the financial bailout package, which was known as the TARP, or the Troubled Assets Relief Program, along with the share provided by private investors.
"Using 75 billion to 100 billion dollars in TARP capital and capital from private investors, the Public-Private Investment Program will generate 500 billion dollars in purchasing power to buy legacy assets with the potential to expand to 1 trillion dollars over time," said the Treasury in a statement.
"This approach is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly," it said. "Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis, as in the case of the Japanese experience."
According to the Treasury, the new long-awaited program will have three major parts:
-- A public-private partnership to back private investors' purchases of bad assets, with the Treasury support coming from the700-billion-dollar financial bailout fund. The government would match private investors, such as hedge funds, dollar for dollar and share any profits equally.
-- Expansion of a recently launched Federal Reserve program that provides under its new Term Asset-Backed Securities Loan Facility, or TALF. Under the new program, the TALF will also address the broken markets for securities tied to residential and commercial real estate and consumer credit.
-- Use of the FDIC, which insures bank deposits, to extend loans to support purchases of toxic assets. The FDIC would also share the risks if the mortgages fell further in value.
According to the Treasury, it works like this: if a bank has a pool of residential mortgages with 100-dollar face value that it is seeking to divest, the bank would approach the FDIC.
The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio. The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids.
Suppose the winning bidder offered 84 dollars, the FDIC would provide guarantees for 72 dollars of financing, leaving 12 dollars of equity. The Treasury would then provide 50 percent of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately 6 dollars, with the private investor contributing 6 dollars.
"Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets," Treasury Secretary Timothy Geithner wrote on Monday's Wall Street Journal.
"The ability to sell assets to this fund will make it easier for banks to raise private capital, which will accelerate their ability to replace the capital investment provided by the Treasury," he said.
U.S. President Barack Obama also hailed the latest plan, saying he was "very confident" that it will work. "We believe this is one more element that is going to be absolutely critical in getting credit flowing again," Obama spoke briefly to reporters after meeting his economic advisors at the White House.
"It's not going to happen overnight, there is still great fragility in the financial systems but we think that we are moving in the right direction," said the president.
Greeted with skepticism
Geithner also acknowledged the uncertainties inherent in the new program, but defended it on Monday as a practical approach.
"There is no doubt the government is taking risk," Geithner said at a press conference. "You cannot solve a financial crisis without the government assuming risk."
Treasury officials are betting that the current low market prices for these assets are driven more by excessive fear than the reality of how the economy will perform, and that the new purchases will help kick-start those markets and return them to more normal functioning, according to U.S. media.
"It is going to be an open bid. That's part of why we're going in with the private sector," said Christina Romer, head of the White House Council of Economic Advisors. "They're going to have money on the line just like we are and the whole idea is to make sure we don't overpay for them."
Two of the largest U.S. money managers, Black Rock and PIMCO, also expressed interest in participating in the plan.
"This is perhaps the first win/win/win policy to be put on the table and it should be welcomed enthusiastically. We intend to participate and do our part to serve clients as well as promote economic recovery," Bill Gross, PIMCO's co-chief investment officer told reporters.
"We are very supportive," said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable. "We think it is a useful tool in the arsenal against liquidity problems."
U.S. stocks staged the strongest rally this year on Monday, a sign that Wall Street was optimistic about the new program. All major indexes jumped more than 6 percent, as big banks such as Citigroup, JPMorgan and Bank of America climbed over 20 percent.
However, one particularly treacherous hurdle for the plan is how to persuade the private investors to come to the table.
"After last week's high-volume debate over bonus payments to AIG employees, hedge funds and private equity firms may be reluctant to play ball, for fear that the government will change terms of the deal retroactively," said the Washington Post in a report.
Some lawmakers also expressed skepticism about the new plan. House Republican Whip Eric Cantor called it a "shell game" that hid the true cost.
"As described, the plan seems to offer little incentive for private investors to participate unless the subsidy is made so rich that it comes at the expense of the taxpayer," Cantor said ina statement.
Nobel economics laureate Paul Krugman slammed that the plan was based on "financial policy despair."
"The Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt," Krugman wrote in the New York Times.
"So this isn't really about letting markets work. It's just an indirect, disguised way to subsidize purchases of bad assets," he added.
(Xinhua News Agency March 24, 2009)
