How much risk is too much risk?
Treasury chief Geithner bets that assets will go up in value. But if he's wrong, the losses could be big.
The FixersWASHINGTON (CNNMoney.com) -- The Obama administration has a new plan to wipe toxic assets from banks' books, but it forces the government to make a calculated gamble.
Nobody can say what the final bill could be to taxpayers, but the government is effectively betting that the value of these assets will go up. If policymakers are right, the government unfreezes the credit markets and shares in the profits. But if they're wrong, the cost could be hundreds of billions of dollars.
"You cannot solve a financial crisis without the government assuming risk," Geithner said on Monday. "The only question is how best to do it."
While the markets appeared to cheer on the plan on Monday, some critics started to wonder if the gamble is worth it.
"When they make money, half the profit goes to Wall Street. When they lose money 94% of the loss goes to the taxpayer," Rep. Brad Sherman, D-Calif., told CNN on Monday.
Here's how it will work: An auction between banks and investors will set the price of toxic bank loans and securities. The assets have been tough to price and have been sitting on banks' balance sheets for months with a big question mark.
Once the price has been set, the government will step in with its checkbook.
If the auction price comes in at $84 for a bad bank loan, the government kicks in $6 and the investor kicks in $6. Then the government agrees to back up $72 worth of cheap loans for the investor to purchase the rest of the asset.
If the deal makes money, the investor and the government share equally in the profit. If the asset loses value, the government and private investors initially shoulder the losses equally as well.
But if the losses wipe out the equity the government and the private investors share, taxpayers will take the hit. On top of losing their equity, the feds could - in a worst-case scenario - have to cover the full cost of the loan.
Geithner emphasized on Monday that for that financing to be at risk, the private investor and the government have to lose all of their equity.
So if the asset values increase after the sale, the government makes some money and gets the credit markets rolling. If values continue tumbling, the government could have to shell out hundreds of billions of dollars down the road to cover loans it agreed to back up.
Financial services experts say it's pretty unlikely that all the assets will lose their value at the same time. The bad debt includes lots of mortgages that have become riskier over the years but haven't been defaulted on yet.
"The markets are frozen and the assets are called toxic, not because they have no value, but because ... nobody wants to buy them," Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable, a lobbying group.
However, some economists said on Monday it's possible that the cheap government financing could encourage investors to pay more than the assets are worth with dire consequences for taxpayers.
Brookings Institution economist Douglas Elliott said the problem is that the estimates on the assets' losses have a big range. They could be worth anywhere from 60 cents on the dollar to 30 cents on the dollar, which gives a lot of opportunity for potential overpayment, resulting in taxpayer losses.
"Such losses are certainly not out of the question but it's hard to judge the probability," Elliot said. 
