Treasury unveils 'bad asset' plan
By partnering with private investors, government hopes it can finally flush out toxic assets from banks' balance sheets.
WASHINGTON†(CNNMoney.com) -- The Treasury Department unveiled its long-awaited plan to remove many of the troubled assets from banks' books Monday, representing one of the biggest efforts by the U.S. government so far aimed at tackling the ongoing financial crisis.
Under the new so-called "Public-Private Investment Program," taxpayer funds will be used to seed partnerships with private investors that will buy up toxic assets backed by mortgages and other loans.
The goal is to buy up at least $500 billion of existing assets and loans, such as subprime mortgages that are now in danger of default.
Treasury said the program could potentially expand to $1 trillion over time, but that the hope is that it would not only help cleanse the balance sheets of many of the nation's largest banks, which continue to suffer billions of dollars in losses, but help get credit flowing again.
The government will run auctions between the banks selling the assets and the investors buying them, hoping to effectively create a market for these assets.
To kickstart things, the administration said it will commit $75 billion to $100 billion and would consider how the program is progressing before committing more money.
Even as he acknowledged that the government was taking on risk with this new program, Treasury Secretary Tim Geithner defended it as the best alternative, saying that doing nothing would result in a deeper credit crunch and a "longer, deeper recession."
The plan, which was widely hinted at over the weekend, appeared to be warmly received by Wall Street. The Dow Jones industrial average gained almost 4% in late morning trading Monday, helped by a surge in the financials. Shares of Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500) each climbed about 15% on the New York Stock Exchange.
Investors have been waiting expectantly for details since Geithner first announced the framework of a plan last month to address two of the biggest problems in the banking sector: the toxic assets keeping banks from lending and the shortage of capital at major institutions.
But the latest program may very well add to the cost of federal bailouts to date. So far, the government has spent $2.5 trillion of the more than $12 trillion authorized for programs aimed at propping up the nation's financial services industry and the broader U.S. economy.
One of the biggest difficulties in getting the program off the ground was how to price the soured assets. If the government paid too little, banks would take the hit. But if the government overpaid, then already-soaked taxpayers would feel the pinch.
One nagging concern, however, is whether the government's involvement will actually spur banks and private investor groups, such as hedge funds, pension plans and insurance companies to participate.
Administration officials indicated Sunday they had gotten support from private investors and banks who have been briefed about the program. But some analysts questioned whether the government's help would be enough to push investors and banks toward figuring out a price.
At the same time, there are fears that investors may be reluctant to participate in light of the fact that Congress has retroactively altered the terms of many of the government rescue programs so far.
Bill Gross, co-chief investment officer of Pimco, one of the world's largest bond investment managers, said those concerns were not enough to deter his firm's interest in the program.
He told CNN that Pimco planned to participate and would also apply to the Treasury for one of the available asset manager positions to help run the program. Asset manager BlackRock (BLK, Fortune 500) said it also planned to apply.
Geithner said Monday those asset managers and investors who participate will not have to abide by new caps on executive pay that have been imposed on financial institutions that received bailout money.
"These programs are different programs," Geithner said.
Regulators indicated, however, that they had few other attractive alternatives.
Letting banks continue to hold these assets on their books, for example, would only drag out the crisis and could put the country in a position similar to what happened in Japan during that country's so-called Lost Decade in the 1990s.
But if the government bought all the bad assets on its own, taxpayers would take on all of the risk. By investing with private firms under the current plan, the expectation is that taxpayers would share the risk -- as well as any potential returns.
Much like many of the government rescue efforts so far, the latest plan will rely on cooperation from other top regulators, including the Federal Reserve and the Federal Deposit Insurance Corporation.
The FDIC, the nation's top banking regulator, will conduct an auction for pools of loans banks are looking to sell and would guarantee debt issued by the buyer.
As part of Monday's announcement, the Federal Reserve would also expand its Term Asset-Backed Securities Loan Facility, or TALF, to include lower rated securities backed by residential and commercial mortgages.
The TALF program, which was launched last week, also will help find buyers for issuers of securities backed by other debt, such as auto, credit card, student and small business loans.
President Obama and Geithner have been working for months, even before Obama took office in January, to fashion a comprehensive strategy for rescuing the banks.
Geithner's plans have been weighed down in recent days by congressional and public backlash against retention bonuses paid to employees of American International Group (AIG, Fortune 500), a troubled insurer that is now majority owned by the government.