US unveils public-private plan to buy up toxic assets

The US Treasury unveiled a long-awaited plan Monday to buy up toxic assets clogging the financial system using government funds, loans to investors and guarantees to attract private capital.
The cornerstone of the plan is a "Public-Private Investment Program for Legacy Assets" funded with 75 to 100 billion dollars from the government -- an idea that has generated some praise but also skepticism.
Officials said this approach would "generate 500 billion dollars in purchasing power" and could expand to one trillion dollars.
The plan, the outlines of which were unveiled last month, is a key to helping the ailing banking system recover from massive losses suffered in the US real estate meltdown and stabilizing the economy.

The Treasury said the plan "ensures that private sector participants invest alongside the taxpayer, with the private sector investors standing to lose their entire investment in a downside scenario and the taxpayer sharing in profitable returns."



Treasury Secretary Timothy Geithner said in announcing the plan, "Our job is to try to fix this problem of the financial system at least cost to the taxpayer."

The statement said that "a broad array of investors are expected to participate" in the program including individual investors, pension plans, insurance companies and other long-term investors.

The Treasury and private capital will provide equity financing and the Federal Deposit Insurance Corp. will provide a guarantee for debt financing, which will be used to buy up mortgages and mortgage securities that are frozen because of massive losses linked to the US housing meltdown.

The initiative will contain two elements, one for pools of mortgages to allow banks to sell these to investors; the second will be a fund directed by asset managers to allow public and private capital to buy distressed mortgage securities.

Mark Zandi, chief economist at Moody's Economy.com, said the plan "has a good chance of success."

"This plan relies much less on private investors and much more on direct government purchases of banks' troubled assets," Zandi said.

"Only a handful or so of private investors need to participate in this plan to establish workable auctions for the assets and thus determine a fair price for the assets."

Yet some analysts have been skeptical about whether these assets can be priced and sold under current market conditions, and whether banks holding them would be willing to sell at a deep discount, forcing a loss to be recognized.

The purchase of these assets was the original purpose of the 700-billion-dollar Troubled Asset Relief Program passed by Congress last year, but which backed away from this idea.

Nobel economics laureate Paul Krugman said the plan was based on "financial policy despair."

Krugman wrote on his blog that the main flaw in the plan "is the insistence that the bad assets on banks' books are really worth much, much more than anyone is currently willing to pay for them."

Andrew Busch at BMO Capital Markets said that "no one is sure whether banks will sell these assets to create the program. Other than that, the markets are loving it early."

To allow banks to sell loans, the Federal Deposit Insurance Corp. will conduct an analysis to determine the amount of funding it is willing to guarantee. Investors will be able to bid on these, with financing available with a leverage ratio of up to 6-to-1.

For mortgage securities, the Treasury will approve up to five asset managers to handle these sales.

To reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased under the program. Treasury funds will be invested one-for-one on a side-by-side basis with investors.

Robert Brusca at FAO Economics said the Treasury is "providing low interest loans for a fund with an eight percent private capital stake matched by the government."

He said the government gets half the capital and half the funds gain "but it puts up 92 percent of the money," with investors "getting the same sweet deal as a home owner putting eight percent down and the ability to walk away unscathed if it does not work."