The Treasury Department calls its long-awaited plan to deal with so-called toxic assets a public-private partnership. The plan depends on private investors to supply much of the capital that will be needed to eliminate bad loans and toxic securities from the financial system.
From NPR News, this is ALL THINGS CONSIDERED. I'm Robert Siegel.
After a long wait, investors finally got some details today. The Obama administration outlined its plan to relieve banks of the toxic assets that are at the heart of the financial crisis. Most of those assets stem from real estate loans made at the height of the housing bubble. President Obama expressed confidence in the plan during remarks to reporters at the White House this morning.
President BARACK OBAMA: The good news is that we have one more critical element in our recovery, but we've still got a long way to go.
SIEGEL: Investors liked what they saw, too. The Dow shot up nearly 500 points. That's about seven percent. The administration's plan has the government partnering with private investors to buy up the toxic assets. And for more on that plan, I'm joined now by NPR's John Ydstie. John, first, how would those partnerships work?
JOHN YDSTIE: Well, the short answer is that private investors would put up a little money, and the government would put up a lot of money. And together they would hope to buy up about a trillion dollars' worth of these toxic assets from banks and other financial institutions. If these public/private partnerships make money, taxpayers and investors would share equally in their profits. If there were losses, they'd share equally in the small losses, but taxpayers would be on the hook for the large losses.
SIEGEL: And where would that government money come from?
YDSTIE: Well, there are two main programs. One would buy up mortgage-backed securities. It would use Treasury TARP funds and Federal Reserve loans. The other program would buy troubled individual mortgages, loans that haven't been securitized. It would use Treasury TARP funds and loan guarantees from the FDIC. That's the most well-defined program.
SIEGEL: Well, walk us through that more well-defined program, the one involving the FDIC.
YDSTIE: Okay, here's what would happen. Let's say Bank of America had a pool of nasty mortgages it wanted to get rid of. It would notify the FDIC and the FDIC would set up an auction. Private bidders, which could be other banks, could be individuals or even hedge funds, it would bid for the assets. Let's say the winning bid was $100 million.
Well, the private investors would put up about seven percent of that, $7 million. The Treasury would put up an equal amount, another $7 million. The rest of the purchase would be financed by loans that would be guaranteed by the FDIC. And those loans would cover about 85 percent of the purchase price.
SIEGEL: So about $7 million from the private investors, $7 million from the Treasury TARP program and $85 million in loans backed by the FDIC. It's a huge government contribution, how would the profits or the losses be distributed?
YDSTIE: Well, if there are profits, the government and the private investors share equally. If there are losses, the private investors and the government share equally in the losses up to 14 percent. If the losses go beyond that, they're essentially all absorbed by the FDIC.
SIEGEL: By the public side of it.
SIEGEL: That's the program to buy pools of individual mortgages. What about the program that buys the more complicated mortgage-backed securities that we hear so much about?
YDSTIE: Well, the formula is somewhat different, but I think the gains and losses would be shared in a similar way.
SIEGEL: So why would the government be anxious to go into partnerships where they shoulder so much more risk of loss if the deal goes bad?
YDSTIE: Well, the alternatives for the government are even less attractive, according to Treasury Secretary Tim Geithner, who unveiled the plan today. Here's how he put it in an interview with the financial channel, CNBC.
Secretary TIM GEITHNER (Department of Treasury): You know, this is the best way, in our view, to protect the taxpayer. The alternative approaches, which have the government buying all the stuff, taking on all the risk under a balance sheet, would be much more expensive to the taxpayer. The alternative of letting it just sit there, let these assets just sit in the balance sheets of banks would risk creating a much longer, deeper recession.
SIEGEL: And private investors are ready to participate?
YDSTIE: Yes. Some prominent large investors have suggested that they say see opportunity here and financial markets certainly give thumbs up with the big rally today.
SIEGEL: Yeah, we'll hear from one of those investors in a moment. Criticism as well, though, of this program.
YDSTIE: Yeah. There was criticism. Most prominent among the critics, Paul Krugman, the Princeton economist, New York Times columnist and this year's Nobel Prize winner. He argues the government ought to just bite the bullet and take over shaky banks and sell off the assets. He's very skeptical these public/private partnerships will solve the problem.
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Step 1: A bank has a pool of residential mortgages with $100 million face value that it's seeking to divest. The bank would approach the Federal Deposit Insurance Corp.
Step 2: After conducting an analysis, the FDIC would determine that it would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest private bid — in this example, $84 million — would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.
Step 4: Of this $84 million purchase price, the FDIC would provide guarantees for $72 million of financing, leaving $12 million of equity.
Step 5: The Treasury would then provide half of the equity funding, or $6 million, and the private investor would contribute $6 million.
Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition using asset managers approved by and subject to FDIC oversight
Source: U.S. Treasury
The Obama administration on Monday launched its latest initiative to stabilize global credit markets, with Treasury Secretary Timothy Geithner pleading for patience regarding a partnership between government and private investors that could absorb $1 trillion in banks' toxic assets and jump-start new lending.
The centerpiece of the proposal, according to a fact sheet released by the administration, is a plan to expand the new Term Asset-Backed Securities Loan Facility, or TALF, to start the Public-Private Investment Program for Legacy Assets — a partnership to acquire the bad loans. TALF would buy the loans from banks and then bundle them into privately administered investment funds that would be partially guaranteed by the Federal Deposit Insurance Corp.
The latest effort to jump-start the economy follows a week in which lawmakers tapped a populist nerve, with the House voting to slap a surtax on bonus payments made to employees by American International Group and other companies receiving federal bailout money.
Under the plan, the $200 billion that currently funds TALF would be increased to $1 trillion. The money would be used to purchase older residential mortgage-backed securities that were once highly rated, as well as commercial mortgage-backed securities and asset-backed securities that are highly rated, as loan collateral.
The White House says investors as well as taxpayers stand to profit if they get a bargain. But if the investors overpay, they could lose much of their investment and taxpayers would be on the hook for a lot more.
The Treasury Department would initially hire five or more investment managers from pension funds, insurance companies and hedge funds that can demonstrate an ability to raise private funds to buy securities. Treasury will provide up to 50 percent of the equity capital that the funds will need to get started.
As an example, the fact sheet said a batch of mortgages would be awarded to the highest bidder, with the FDIC providing a debt-financing guarantee for 88 percent of the total investment, leaving 12 percent in equity to be split between Treasury and the private investor.
Geithner, who has endured calls for his resignation over his handling of the crisis in recent days, held a session with reporters in which he acknowledged the public's "deep anger and outrage" over the banking mess.
He said the plan will seek to take a half-trillion dollars in bad assets off banks' balance sheets, a figure he said could eventually grow to $1 trillion.
Geithner said that in general, investors who take part in the program would not be held to any government-imposed salary limits. While Congress is cracking down on big Wall Street bonuses, Geithner says investors need to be confident the rules won't change.
Wall Street opened sharply higher on Monday after the plan was unveiled, following world markets that soared ahead of the announcement, the details of which were leaked over the weekend. Shares in Citigroup — likely to be a major beneficiary — surged.
But critics such as Nobel Prize-winning economist Paul Krugman were skeptical of the plan. Krugman, writing Saturday in The New York Times, said the proposal would do little to prop up the banks at biggest risk.
"This plan will produce big gains for banks that didn't actually need any help; it will, however, do little to reassure the public about banks that are seriously undercapitalized," he wrote. "I fear that when the plan fails, as it almost surely will, the administration will have shot its bolt: it won't be able to come back to Congress for a plan that might actually work."
President Obama said Monday that he is confident that taxpayers will "share in the upside as well as the downside" of the financial crisis, adding that the plan is just one element and that Americans "still have a long way to go."
Material from The Associated Press was used in this report.