Pssst - wanna buy a toxic asset?
Federal officials are considering ways to open up to retail investors its programs to clean up bad loans. Some investment managers are intrigued by the idea.
WASHINGTON (CNNMoney.com) -- Consumers take heed: You too might be able to buy a piece of a government subsidized toxic bank asset. Whether you should is another question.
In their quest to woo investors and clean up the banks, top federal officials are discussing ways to extend a key federal bailout program beyond Wall Street firms and hedge funds to average Joes.
"For retail investors, we want to make sure whatever participation they would have would be suitable," Federal Deposit Insurance Corp. Chairman Sheila Bair said last week on a conference call with investors.
Experts say the government wouldn't allow consumers to, say, plunk down retirement savings directly on a piece of a devalued mortgage. Instead, investors would be given the chance to buy shares of special funds that contain the assets.
Several top institutional investment management firms, including BlackRock (BLK, Fortune 500) and Pimco, are in the planning stages of such funds, according to consultants working on deals. Spokesmen for both companies declined to comment. Another firm, Eaton Vance Managed Investments, is also evaluating whether to offer such special funds, a spokeswoman said.
Allowing retail investors to buy into the bad assets could counter the perception that the government is only looking out for Wall Street. If the effort succeeds, consumers could share in the profits. But the program is risky: The investments could tank and consumers could lose money.
For its part, the Treasury Department isn't saying whether funds targeted at retail investors will get a final nod. "We want broad participation and we will be evaluating all applications," Treasury spokesman Andrew Williams said.
Treasury is still working with other agencies to hammer out the final details of how to enact the Public-Private Investment Program. Tim Geithner, the treasury secretary, revealed the basic structure last month.
Under the program, the government will team up with investors, with each putting up half the equity to purchase a legacy loan or security. The government would also guarantee cheap financing to pay for the rest of the asset.
Funds for retail investors would have to first clear some regulatory hurdles, say lawyers who represent financial firms.
For example, regulations restrict open-end funds, like the kind investors buy through mutual fund companies, from investing more than 15% in "illiquid" assets - those not easily and quickly converted into cash. And the legacy loans and securities at the center of the Treasury program are about as illiquid as things get, said investment management attorney Bruce Leto of Stradley Ronon.
So investment firms are talking mostly about creating closed-end funds that invest in toxic assets.
Closed-end funds, like public companies, sell shares that are traded on an exchange. Under the PPIP, an investment firm would create a portfolio of investments in toxic assets and sell a limited number of shares. Buyers who later want to get out would need to find someone else to buy their shares. Like stocks, the value of the portfolios would depend on their market performance.
But purchasing toxic assets through closed-end funds could be tricky. It's unclear whether regulators would sign off on the idea of exclusively investing closed-end funds in toxic assets, according to banking lawyers.
"It's highly unusual, even without a limit on liquidity, to invest 100% in these kinds of things," Leto said.
No matter how a retail fund was structured, the biggest sticking point is the value of the legacy assets, which remains a key unknown for potential Wall Street and retail investors. While auctions would set the price for each one, critics have warned that the cheap financing could persuade investors to bid too high and inflate the prices.
Inflated prices would mean investors could lose everything they put in and that the government is on the hook for even more.
"For a retail investor, it's a highly risky option, because these are not a structure that has any kind of history that allows you to evaluate the advantages and the disadvantages," said Mercer Bullard, an assistant law professor at the University of Mississippi.
CNNMoney.com reached out to 13 retail members of the American Association of Individual Investors, and nine said they would consider buying toxic assets if offered through a fund. Several cited fortunes made during the savings and loan crisis 20 years ago.
"Individual investors are starved for products," said retail investor Al Blomquist of Allendale, N.J., a retiree who dabbles in investment managing.
Blomquist said a lot of his older clients whose retirement savings have declined are looking for financial products to give them better yields and make up for recent losses. "I hate to say it, but most of my clients only care about their profit."
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