Geithner details 'toxic asset' purchase plan

The plan for toxic assets is the last and most vital link of the Obama administration's broad financial-rescue program.

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WASHNGTON (MCT) - Treasury Secretary Timothy Geithner took the wraps off a long-awaited key component of the Obama administration's bank rescue plan Monday, detailing a public-private partnership to buy up the so-called toxic assets that are polluting bank balance sheets.

After a disastrous first attempt to explain the plan Feb. 10 that sent markets into a nose dive because of the lack of detail, Geithner spelled out more clearly Monday how he'll use $75 billion to $100 billion in taxpayer money to leverage the purchases of up to $1 trillion in securities and loans held by banks that are eroding confidence in the financial system.

"I'm very confident this scheme dominates all the alternatives," the embattled treasury secretary said shortly before the 9:30 a.m. EDT opening bell for trading on the New York Stock Exchange.

After some hesitation, traders apparently digested the plan and signaled approval. The Dow Jones Industrial Average surged and was up almost 300 points in midmorning trading.

Under Geithner's plan, taxpayer money and private-sector investment will flow into the Public-Private Investment Program. The Federal Reserve and the Federal Deposit Insurance Corp. will help provide low-cost financing to subsidize the purchases of distressed bank assets. The Fed will bolster purchases of mortgage-backed securities, the pools of mortgages that are bundled and sold to investors as mortgage bonds. The FDIC will support financing for purchases of mortgage-related loans.

The money to match the private investment will come from the Troubled Asset Relief Program, which was created during last October's $700 billion Wall Street bailout. That bailout originally envisioned the government purchasing the distressed assets, but the Bush administration backed away from that because it would have involved the government paying inflated prices to unfreeze the credit markets.

In laying out his plan, Geithner said he sought to strike a balance between letting the market alone sort out these problems _ risking a deeper, longer recession _ and having the government alone buy these assets, risking taxpayers paying too much.

The compromise was to have private companies _ namely hedge funds, private-equity funds and perhaps pension funds _ bid against one another for distressed assets to find their market prices, and to sweeten the deals by having the government join them as an investment partner.

If the plan works, taxpayers would share in the upside as markets unfreeze and housing-related securities begin trading again. If the investments lose money, taxpayers will share the loss.

Some critics think that the taxpayer is more at risk than private investors are under the Geithner plan.

"The value of cheap multi-year government financing is quite significant, as is the government's promise to put a floor under losses at 10 percent or 20 percent of what the investor puts up. It is possible that these incentives will cause investors to overpay for the assets, with most of the eventual losses flowing to the taxpayer because of the downside protection offered the investors," wrote Douglas Elliott, a research fellow at the Brookings Institution, a center-left research center in Washington.

"For example, it could be rational for investors to offer 40 cents on the dollar, calculating that they would benefit sharply if the price went to 50 cents, while the government would absorb most of the losses if the value fell to 30 cents on the dollar," Elliott wrote.

Pricing was, is and will be the complicating factor in solving the banking meltdown. At the center of the nation's banking problems are trillions of dollars' worth of mortgage-backed securities. Banks have been forced to write down the value of these assets quarter after quarter, because there are no buyers for them. That makes the banks hoard their capital, in turn, to comply with regulatory requirements, rather than lending it out. The result is a credit crunch that's contributing to the economic slowdown.

The banks won't sell their declining assets at fire-sale prices either, however, in the belief that they have maturity dates and will return to value over time. Investors have been unwilling to touch these assets unless they get steep discounts. Result: no market.

The government's plan seeks to create a market for these assets.

"I think you are going to see a fair amount of interest in this," Geithner said.

If Geithner's plan doesn't work, it could lead to nationalizing some banks, something that some high-profile analysts have advocated, including former Treasury Secretary James Baker and Nobel Prize-winning economist Paul Krugman, pointing to Sweden's successful nationalization of banks in the early 1990s.

"We're the United States of America. We are not Sweden," Geithner said, suggesting that the U.S. financial system is much larger and more complex than any other and includes the world's largest capital markets and plenty of nonbank financial institutions. To him, these realities make copying Sweden inappropriate.

If Geithner's plan succeeds in establishing some preliminary pricing and the market begins to revive, the administration is likely to seek more money to help it grow. President Barack Obama proposed setting aside $250 billion in his fiscal 2010 budget for potential bank-rescue efforts, and may seek $750 billion.

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However, Congress must approve any such move, and the mood on Capitol Hill is hostile to more taxpayer bailouts.

Some analysts see promise in Geithner's approach.

"The government can then come in and buy these assets on a large scale at these prices. (Roughly) $1 trillion is not enough; it probably needs to be twice that," said Mark Zandi, the chief economist for Moody's Economy.com, a forecaster in West Chester, Pa. "But if the plan works well enough, I think Congress will provide more money to solve the problem once and for all. This plan makes me more optimistic about the financial prospects for the financial system and the economy."

Obama, flanked by Geithner and Federal Reserve Chairman Ben Bernanke, called this latest plan an important element of a multi-pronged approach to thawing credit markets, and he dialed down expectations, cautioning, "It's not going to happen overnight."

The plan for toxic assets is the last and most vital link of the Obama administration's broad financial-rescue program. Under the whole program, federal banking regulators have started stress tests on the nation's 19 largest banks to determine whether they have sufficient capital to survive an even deeper recession.

By the end of April, these banks, if they're deemed insufficiently capitalized, will have to raise capital in the private sector within six months or get cash from the government. In the latter case, taxpayers would get stakes in the banks.

Since Feb. 10, the Treasury also has rolled out a number of incentives for players in the housing sector to help refinance or modify distressed mortgages. The Treasury and the Federal Reserve also have jointly put into place a program to have the Fed purchase bundles of credit card debt, student loans, car loans and small-business loans in hopes of sparking lending in the troubled economy.