Treasury Releases Details of Toxic Asset Plan

As expected, the U.S. Treasury released details Monday morning before market open of the latest approach to clear toxic loans and securities off of bank’s balance sheets. Saying that “the financial system is still working against economic recovery,” the Treasury said it will earmark up to $100 billion in funds from the Troubled Asset Relief Program, hoping to attract capital from private investors in order to generate $500 billion in purchasing power to buy legacy assets. The ‘three-pronged’ approach put together by Treasury secretary Timothy Geithner has two parts. The first will see the Federal Deposit Insurance Corp. provide a guarantee for debt financing issued by the public-private investment funds to fund so-called ‘legacy loan’ purchases, while the Federal Reserve will further expand the Term Asset-Backed Securities Facility to to include non-agency RMBS that were originally rated AAA, and outstanding CMBS and ABS that are currently rated AAA. Read the Treasury white paper outlining the public-private partnership plan. The $500 billion program could expand to $1 trillion over time, the Treasury said. The program — whether whole loans or securities — involves significant exposure for the U.S. taxpayer. In the case of whole loans, investors take an equity position in most cases below 10 percent of the investment pool; the example provided by the Treasury shows private investors retaining just $6 in exposure out of an $84 bid on $100 in par value. Likewise, in the case of securities, for every $100 put up by an investor to make a purchase, the government will put up as much as an additional $300 in equity interest, according to a Treasury fact sheet. “Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets,” Geithner wrote in an op-ed published by the Wall Street Journal. “The ability to sell assets to this fund will make it easier for banks to raise private capital, which will accelerate their ability to replace the capital investments provided by the Treasury.” Price discovery The plan seems to face one key hurdle that bedeviled Geithner’s predecessor Henry Paulson: price discovery. Geithner is hanging his hopes on the ability of the private market to properly price the assets — the problem, of course, is that the market already has, according to most investors HousingWire spoke with. But market prices don’t just reflect the value of an asset; they also tend to reflect the cost of capital needed to finance the purchase of an asset, distressed or otherwise. The real effect of Geithner’s plan is to reduce the cost of capital to investors, sources told HW on Monday — a gambit that hopes such a reduction in capital costs, along with a de facto transfer of downside risks to the government’s balance sheet, can entice would-be buyers to increase their bids to a level banks would be willing to sell at. From that perspective, some investors expressed hope. “It might be enough,” said one investor, who runs a distressed hedge fund in the mortgage space. “We’ll see.” “The benefits to us are incredible,” said another, who runs a mid-sized fund that specializes in purchasing non-performing mortgages. “Today there is no reasonable financing available for acquistions of these portfolios, either from the sellers themselves, or other institutions.” Geithner does face some problems from would-be investors, however, according to the Wall Street Journal; investors are “leery of working with the government for fear the rules will change midstream,” according to the news daily. The legislation that established TARP put some strict restrictions on firms using government money, restrictions that private capital is likely far more leery of given the bonus debacle over at American International Group, Inc. (AIG). The plan’s reliance on existing TARP funding also recognizes a key political hurdle as well; the Obama administration likely doesn’t have the ability to approach Congress for further funding for Wall Street. Pundits have suggested this reality forced the Treasury to recruit the Fed — whose balance sheet is effectively unlimited — and the FDIC, which some media reports have suggested is an uneasy partner in the new government program. Regardless, for Geithner, this plan represents a likely last stand for the embattled Treasury chief, who has had a rocky start and already has seen investors strongly question his ability to manage this crisis; more than 70 positions within Treasury remain yet unfilled, a critical shortfall in human capital that critics say is hampering the government’s ability to manage the worst financial crisis in seven decades. President Barack Obama said on CBS’s “60 Minutes” Sunday that Geithner’s job was safe. Write to Paul Jackson at Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.

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