By Don Miller
With every proposed financial fix-up plan for the U.S. banking system, there's always been one major sticking point: The logjam of hard-to-price - and even "toxic" - assets clogging the balance sheets of banks, investment houses or any other type of company with an involvement in the financial-services sector.
The Barack Obama administration yesterday (Monday) unveiled a detailed strategy for attacking that problem. The plan, which fleshes out a very broad strategy sketched out on Feb. 10, relies on a joint effort with private investors to rid banks of up to $1 trillion worth of the toxic assets that are clogging the financial system and blocking an economic recovery.
Labeled as the "Public-Private Investment Program," the administration's strategy is designed to finance purchases of devalued real-estate assets. It will be funded with $75 billion to $100 billion of U.S. Federal Reserve and Federal Deposit Insurance Corp. (FDIC) debt guarantees, as well as the funds remaining in the U.S. Treasury Department's Troubled Asset Relief Program (TARP).
U.S. Treasury Secretary Timothy F. Geithner is betting this plan will finally establish market values for the toxic debt left over from the U.S. housing bust, and that getting the private market involved will minimize the risk that taxpayers will overpay for assets.
U.S. stocks soared in a sign that investors like the aggressive nature and unique approach of the plan. The Standard & Poor's 500 Index soared 7.08%, while the blue-chip-laden Dow-Jones Industrial Average advanced 6.84% in trading yesterday. The indices are still down about 10% since Geithner first outlined the Obama administration's plans on Feb. 10.
This newfound investor confidence follows a week in which the Obama administration endured harsh rebukes for overspending, and for failing to block more than $165 million in bonuses awarded to employees by embattled insurer American International Group Inc. (AIG) - which has received more than $180 billion in taxpayer-provided bailout money.
Lawmakers on Capital Hill reacted last week by passing a bill to tax 90% of the bonuses, with some even calling for Geithner's resignation.
But the administration stood by Geithner over the weekend and said the plan was the right solution for ridding the banking system of stubborn loans and assets - and involving private-sector investors, but without actually catering to Wall Street.
"This has never been about helping Wall Street or helping a firm that made mistakes," Christina Romer, head of the Council of Economic Advisers, told The Associated Press. "It's absolutely about helping a system so that people can get their student loans, and [so] that families can buy their house and buy their cars, and small businesses can get their loans."
Private Funds Crucial
Government officials contend that they have found the right mix to attract private investors and make inroads on what could be more than $2 trillion in troubled assets on banks' books.
The administration has stressed that the problems are so serious that the government cannot solve them alone, and Geithner emphasized that market participation is vital.
"For these programs to work investors have to be prepared to take some risk," he told a pool of reporters.
But it may be some time before it's clear whether his approach will work because officials still have to select private asset managers, and banks have to decide whether or not they will sell their illiquid investments.
"The big question is what is the incentive for the banks to sell?" Dino Kos, managing director at Portales Partners LLC in New York, and former executive vice president at the New York Fed, told Bloomberg News. "What is the incentive for a hedge fund to pay a price close to where the banks have it marked at?"
The backlash in Congress might mean private firms will be hesitant to take part in Geithner's public-private partnership, even though government-backed financing will mean the private-sector investors face lower risks and enjoy heightened opportunities for profits.
To encourage private investors to be more supportive, the government will put up most of the money, shouldering more risk than the investors. Other enticements will come in the form of low-interest loans to purchasers, which could include hedge funds, private-equity firms, insurers and pension funds.
"This approach is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly," the Treasury Department said in a statement. "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 plan calls for dividing funding from the Treasury equally between two programs to alleviate distinctly different problems hanging over the banking industry:
- Legacy Loans: Half of the capital will go to purchase a pool of troubled loans stuck on bank balance sheets that have made it difficult for banks to access private markets for new capital and limited their ability to lend. After private fund managers put up the other half, the FDIC will guarantee financing for the investors, up to a maximum of six times the capital provided.
- Legacy Securities: In order to generate prices for securities backed by mortgages that have become highly illiquid, the Treasury will provide up to 80% of the initial capital, with the rest of the investment coming from private funds. The FDIC would then offer financing for up to six times the pooled amount.
The Federal Reserve will also bump the Term Asset-Backed Securities Loan Facility, or TALF, from $200 billion up to $1 trillion and begin accepting mortgage-related securities as loan collateral.
Additionally, the Treasury will approve as many as five asset managers "with a demonstrated track record of purchasing legacy assets" and match their money one-for-one to buy securities banks want to unload.
Austan Goolsbee, a member of the White House Council of Economic Advisers, expressed confidence that private investors will step up.
Goolsbee said in an interview with Bloomberg Television that "you will start to see this buying up the assets" shortly after the private asset managers are chosen by May.
"The private sector will compete to be partners with the government," Goolsbee predicted. "I don't believe they should expect to be treated the same way as a deadbeat type of institution like AIG or Fannie Mae (FNM)."
Two of the largest U.S. money managers, BlackRock Inc. (BLK) and PIMCO Financial Inc., chimed in and expressed interest in participating.
"This is perhaps the first win/win/win policy to be put on the table and it should be welcomed enthusiastically. We intend to participate and do our part to serve clients as well as promote economic recovery," Bill Gross, PIMCO's co-chief investment officer, told Reuters.
More May be Needed
Despite yesterday's near-euphoric jump in stock prices, some analysts said the need for further funding may temper the plan's actual long-term results. The administration said the program has the capacity to purchase $500 billion - and possibly as much as $1 trillion - in troubled loans, much of which reaches all the way back to the initial declines in what's become a total collapse of the housing market, as that's led to a wave of foreclosures that continues to mount.
Mark Zandi, an economist with Moody's Economy.com, estimated the government would need another $400 billion with the TARP bailout fund nearly tapped out by capital injections to banks and lifelines provided to the auto companies and AIG.
Current sentiment in Congress is hostile to another bailout, reflecting taxpayer frustration with Washington, and puts the possibility of further funding in serious doubt.
News and Related Story Links:
Money Morning Special Report:
The Lost Decade: How the U.S. Financial Crisis Resembles Japan's Ten Years of Misery - And How to Play it.
The Associated Press:
Administration launches plan to help banks
Geithner Relies on Investors for $1 Trillion Plan
U.S. woos buyers of toxic assets.
Money Morning Week Ahead Analysis:
As Criticisms Over Leadership Mount, Obama Administration Makes Plans to Battle Back.