U.S. Lays Out Plan to Buy Up to $1 Trillion in Risky Assets

U.S. Lays Out Plan to Buy Up to $1 Trillion in Risky Assets

Todd Heisler/The New York Times
President Obama met with his economic team, including the Treasury secretary, Timothy F. Geithner, at the White House on Monday.

By BRIAN KNOWLTON and EDMUND L. ANDREWS
Published: March 23, 2009

WASHINGTON — The Obama administration formally presented the latest step in its financial rescue package on Monday, an attempt to draw private investors into partnership with a new federal entity that could eventually buy up to $1 trillion in troubled assets that are weighing down banks and clogging up the credit markets.

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The Dow Jones industrial average was up sharply in afternoon trading on Monday, gaining more than 270 points. When the Treasury secretary, Timothy F. Geithner, spoke on Feb. 10 of a bank rescue plan without offering much detail, investors took that as a worrying sign and the Dow fell sharply, losing 380 points.

The Treasury secretary did not deny the uncertainties inherent in the new program on Monday but defended it as a practical approach. “There is no doubt the government is taking a risk,” Mr. Geithner said, “the only question is how best to do it.”

President Obama said later that he and his economic advisers were “very confident” that the program outlined by Mr. Geithner would start to unclog the credit markets.

“It’s not going to happen overnight,” the president said after meeting with his economic team. “There’s still great fragility in the financial systems. But we think that we are moving in the right direction.”

The president also reiterated his pledge “to design the regulatory authorities that are necessary to prevent this kind of systemic crisis from happening again.”
The success or failure of the plan carries not only enormous stakes for the nation’s recovery but certain political risks for Mr. Geithner as well. At least two Republican lawmakers have called for his resignation. And on Sunday, Senator Richard C. Shelby of Alabama, the ranking Republican on the Banking Committee, told Fox News that “if he keeps going down this road, I think that he won’t last long.”

Initially, a new Public-Private Investment Program will provide financing for $500 billion in purchasing power to buy those troubled or toxic assets — which the government refers to more diplomatically as legacy assets — with the potential of expanding later to as much as $1 trillion, according to a fact sheet issued by the Treasury Department.
At the core of the financing package will be $75 billion to $100 billion in capital from the existing financial bailout known as TARP, the Troubled Assets Relief Program, along with the share provided by private investors, which the government hopes will come to 5 percent or more. By leveraging this program through the Federal Deposit Insurance Corporation and the Federal Reserve, huge amounts of bad loans can be acquired.

The private investors would be subsidized but could stand to lose their investments, while the taxpayers could share in prospective profits as the assets are eventually sold, the Treasury said. The administration said that it expected participation from pension funds, insurance companies and other long-term investors.

The plan calls for the government to put up most of the money for buying up troubled assets, and it would give private investors a clearly advantageous deal. In one program, the Treasury would match, one for one, every dollar of equity that private investors invest of their own money in each “Public Private Investment Fund.”

On top of that, the F.D.I.C. — tapping its own credit lines with the Treasury — will lend six dollars for each dollar invested by the Treasury and private investors. If the mortgage pool turns bad and runs big losses, the private investors will be able to walk away from their F.D.I.C. loans and leave the government holding the soured mortgages and the bulk of the losses.

The Treasury Department offered this example to illustrate how the program would work: A pool of bad residential mortgage loans with a face value of, say, $100 is auctioned by the F.D.I.C. Private investors submit bids. In the example, the top bidder, an investor offering $84, wins and purchases the pool. The F.D.I.C. guarantees loans for $72 of that purchase price. The Treasury then invests in half the $12 equity, using funds from the $700 billion bailout program; the private investor contributes the remaining $6.

An attractive feature of the program is that it will allow the marketplace to establish values for the assets — based, of course, on the auction mechanism that will signal what someone is willing to pay for them — and thus might ease the virtual paralysis that has surrounded those assets up to now.
For a relatively small equity exposure, the private investor thus stands to make a considerable return if prices recover. The government will make a gain as well. In the worst case, the bulk of the risk would fall on the government. The presumption, of course, is that the auction will lead to realistic purchase prices.

One institutional investor said he was surprised that the government was lending so much of the money, saying that private investors have been willing to buy up pools of mortgage-backed securities with less “leverage” or outside borrowing than the Treasury proposed on Monday.
The true magnitude of the toxic-asset purchase program could amount to well over $1 trillion. Buried in Mr. Geithner’s announcement was the detail that the Treasury would sharply revise and expand its joint venture with the Federal Reserve, known as the Term Asset-backed Secure Lending Facility, which was originally created to finance consumer lending and some forms of business lending.

Starting soon, that program will be expanded to finance investors who want to buy existing mortgages and mortgage-backed securities, including commercial real estate mortgages. By allowing the so-called TALF program to buy up older assets, as well as new loans, the Treasury and Fed will be putting nearly an additional $1 trillion on the line — on top of all the money being provided through the F.D.I.C. program and the Treasury partnership programs announced on Monday.

The department defined three basic principles underlying the overall program.

• First, by combining government financing, involving the F.D.I.C. and the Federal Reserve, with private sector investment, “substantial purchasing power will be created, making the most of taxpayer resources,” the fact sheet said.
  
• Second, private investors will share both in the risk and in the potential profits, the Treasury Department said, “with the private sector investors standing to lose their entire investment in a downside scenario and the taxpayer sharing in profitable returns.”
  
• The third principle is the use of competitive auctions to help set appropriate prices for the assets. “To reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased,” the department said.

By emphasizing that private investors will share in the risk, the Treasury Department seemed to be seeking to reassure ordinary taxpayers that they will not bear the entire downside burden of yet another $1 trillion program.

At the same time, administration officials strove over the weekend to reassure potential investors that they would not be subjected to the sort of pressures, criticism and public outrage that followed reports of multimillion-dollar bonuses to executives of the American International Group.

The Treasury Department defended its approach as a compromise that would avoid the dangers both of being too gradual an approach and of burdening taxpayers with the entire risk.

“Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis, as in the case of the Japanese experience,” the department said. “But if the government acts alone in directly purchasing legacy assets, taxpayers will take on all the risk of such purchases — along with the additional risk that taxpayers will overpay if government employees are setting the price for those assets.”

The plan relies on private investors to team with the government to relieve banks of assets tied to loans and mortgage-linked securities of unknown value. There have been virtually no buyers of these assets because of their uncertain risk.

But some executives at private equity firms and hedge funds, who were briefed on the plan Sunday afternoon, are anxious about the recent uproar over millions of dollars in bonus payments made to executives of the American International Group.

Some of them have told administration officials that they would participate only if the government guaranteed that it would not set compensation limits on the firms, according to people briefed on the conversations.

Mr. Geithner made it clear on Monday that no limits on executive compensation would be imposed on companies that invest — unless the companies are already subject to such limitations as recipients of TARP money — because the government does not want to discourage investor participation.

Eric Dash and Rachel L. Swarns contributed reporting from Washington, and Andrew Ross Sorkin from New York.

http://www.nytimes.com/2009/03/24/business/economy/24bailout.html?_r=1&hp