RENEE MONTAGNE, host:
This is MORNING EDITION from NPR News. I'm Renee Montagne.
STEVE INSKEEP, host:
And I'm Steve Inskeep. We're going to follow up now on a plan to buy up to $1 trillion in so-called toxic assets, assets so toxic that up to now nobody's been willing to buy them. Treasury Secretary Tim Geithner unveiled a plan to bring in private investors by getting the government to put up money and share the risk, and by buying those toxic assets they get off the books of troubled banks and other institutions.
The announcement sent the stock market upward this week, of course, but also prompted a lot of questions. So to help the rest of us try to think through what this means, we have NPR's Planet Money correspondent David Kestenbaum in the studio.
David, good morning.
DAVID KESTENBAUM: Good morning, Steve.
INSKEEP: So how are you going to explain this?
KESTENBAUM: We're going to act it out. You're going to play the private investor and I have a toxic asset to sell you.
INSKEEP: Oh, okay. So I'm some billionaire with a lot of money. And…
KESTENBAUM: I have some pictures.
INSKEEP: And here - oh, this is the asset?
INSKEEP: It's a car.
KESTENBAUM: It's the closest thing I have to a toxic asset — a 1992 Toyota Corolla.
INSKEEP: Thank you for including the photograph of the odometer showing 103,787 miles on this. Well done.
KESTENBAUM: That's why I want to get rid of it. And Steve, I'm going to make you an initial offer of $1,200.
INSKEEP: You've got to be out of your mind. I might pay 800.
KESTENBAUM: It's got a cassette deck, Steve.
(Soundbite of laughter)
INSKEEP: It does. There's a photograph right here. No, 850 — I'll pay you that much.
KESTENBAUM: Come on, Steve. I've got a family to feed.
INSKEEP: Okay, a thousand.
KESTENBAUM: All right. Deal. So we just had a little auction here. And that is basically how the price for a toxic asset — a mortgage-backed security — would be determined, though you'd have more people bidding. You get the basic idea. And the important part actually comes next, which is how you pay for the car.
INSKEEP: Well, I know I agreed to $1,000, but I've got my wallet here. I don't quite have $1,000 in it. Do I have to put up the whole $1,000?
KESTENBAUM: No. So you only have to put up maybe $200.
INSKEEP: Who's going to put up the other $800?
KESTENBAUM: Well, the government is going to go in on this investment with you, and it's going to put in $200. And you and the government will co-own the car.
INSKEEP: Two hundred plus 200 — it's a $1,000 car.
KESTENBAUM: Right. So we've only accounted for $400 of the price. The other $600, that has to come in the form of a loan. And in some cases, some parts of this plan, that loan would also come from the government.
INSKEEP: I guess this happens all the time in the financial markets. It's called leverage, where I invest a little money and borrow a bunch more. But in this case it's the government that's loaning me the money to make this purchase of this fine Toyota Corolla.
KESTENBAUM: That is why investors like this plan. You get to buy a big expensive thing without a lot of money. And if that big thing increases in value, you make big profits, right? And on the downside — this is actually -the really good part of this for you as an investor, is that if you take the car, you leave my driveway with it and it's a piece of junk and it dies, you don't have to repay the loan. It's what's called a non-recourse loan.
INSKEEP: Now, I mention that there have a lot of questions about that this week, even though the markets went up. And one of the questions is why on Earth is that a good deal for the government to loan all that money and take so much more of the risk than that investor who puts in the 200 bucks?
KESTENBAUM: So here's the best-case scenario: The banks get the stuff off their balance sheets.
KESTENBAUM: Private investors — you — you make money. And the taxpayers in theory make money because they're going in on buying the stuff with you — the really smart investor. So if you made a good investment, you gain and we gain, and that in the big picture one of the central problems in this crisis gets a lot better.
INSKEEP: These bad assets go away; they get dealt with. Banks are free in theory to loan again.
INSKEEP: Okay, what's the worst-case scenario?
KESTENBAUM: Well, there are actually a long list of potential snags. Critics -Paul Krugman, the New York Times columnist, Nobel laureate among them - say that the rules of the game are set up so that really the taxpayer's going to lose.
And the argument is basically that the government is doing so much to help the private investor that the private investor has this incentive to swing for the fences — bid a higher price for the toxic assets than they're really worth or just take real chances. The investor may win on one and lose on nine and so he ends up doing well, but the government loses on nine and taxpayers get hurt.
INSKEEP: So what does the Treasury Department have to say about assuming this huge risk?
KESTENBAUM: Tim Geithner said this week that there's definitely risk for the taxpayer. But he says this plan hands down is the best of all the options that he looked at. I talked to David Beim; he's a professor of banking at Columbia University, who also likes the plan.
Professor DAVID BEIM (Columbia University): I really think that we've got to do something about these assets. You can't just let them sit there festering. They will impact our banking system for a decade if you do. That's what happened in Japan. So I do think the government is right to try and discover some kind of a market for these assets.
INSKEEP: That's David Beim at Columbia. David Kestenbaum is here in the studio. How soon do we find out if this is actually working, David?
KESTENBAUM: We will actually find out one day. I mean, the government will have bought these toxic assets for some price. And in the future we'll find out, just like when you buy that car: Was it a good deal or did I get ripped off? But one day we will actually know whether this was a good idea for the taxpayer.
INSKEEP: NPR's David Kestenbaum is with Planet Money, our blog. Thanks very much.
KESTENBAUM: You're welcome.
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