Secretary Geithner's "Toxic Assets" Plan
Treasury Secretary Tim Geithner yesterday announced his new plan to help troubled banks remove toxic assets from their balance sheets. The new program is known as “The Public-Private Investment Program.”
By Christy Harvey, Mic Check Radio
March 23, 2009
(AP/Gerald Herbert)
Know Five Things
1. What is a “toxic” or “legacy” asset?
CBS News summarized it like this: “Normally banks can sell their healthy assets, such as a borrower’s timely paid mortgage, to other banks. This allows Bank A to get money quickly and Bank B to profit from the interest that the homeowner is paying. But if you go into foreclosure and the price of your home drops below the value of the loan itself, then that asset, namely the mortgage, is losing money. It becomes toxic and sits on the banks’ balance sheets like a black hole. Since the banks can’t tell how large the black holes are on other banks’ balance sheets, they have no confidence to lend money to each other and they stop making new loans, clogging up the nation’s financial system.” [CBS News]
2. How the plan works.
In the most basic terms, “The U.S. government will offer hundreds of billions of dollars in equity and loan guarantees to investors who bid against one another to buy troubled assets from banks.” How it works: “Under the plan, the government and private investors will invest together to buy up between $500 billion and $1 trillion worth of real estate-related loans and securities from banks. The government will use up to $100 billion from the Troubled Assets Relief Program, matched by private funds, to capitalize the purchases. “ The Treasury hopes the plan will “ease the virtual paralysis” that currently surrounds the toxic assets, so “that instead of hoarding cash in case those assets continue to lose value, banks will resume lending money once the toxic assets are off their books.” [Washington Post] [NY Times]
3. Pros.
The Treasury Department outlined three “principles” of the plan. From the Treasury Department Fact Sheet:
Maximizing the Impact of Each Taxpayer Dollar: First, by using government financing in partnership with the FDIC and Federal Reserve and co-investment with private sector investors, substantial purchasing power will be created, making the most of taxpayer resources.
Shared Risk and Profits With Private Sector Participants: Second, the Public-Private Investment Program ensures that private sector participants invest alongside the taxpayer, with the private sector investors standing to lose their entire investment in a downside scenario and the taxpayer sharing in profitable returns.
Private Sector Price Discovery: Third, 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 under the program.
4. Cons
Economist Paul Krugman isn’t a fan of the plan, warning, “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. And 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.” The blog “Calculated Risk” concurs, writing, “The FDIC plan involves almost no money down. The FDIC will provide a low interest non-recourse loan up to 85% of the value of the assets. ... With almost no skin in the game, these investors can pay a higher than market price for the toxic assets (since there is little downside risk). This amounts to a direct subsidy from the taxpayers to the banks.” [NY Times] [Calculated Risk]
5. Wall Street Reacts
Wall Street reacted positively to the plan. After Geithner’s announcement, the Dow Jones Industrial Average rose 497 points in afternoon trading, or more than 6%. [WSJ]
Read Additional Resources
“My Plan for Bad Bank Assets,” Treasury Secretary Tim Geithner, WSJ, 03-23-09. [WSJ]
- Excerpt: “...The Public-Private Investment Program is better for the taxpayer than having the government alone directly purchase the assets from banks that are still operating and assume a larger share of the losses. Our approach shares risk with the private sector, efficiently leverages taxpayer dollars, and deploys private-sector competition to determine market prices for currently illiquid assets. Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience…”
“Treasury Department Releases Details on Public Private Partnership Investment Program Fact Sheet,” Treasury Department. 03-23-09.[Treasury Fact Sheet]
- Excerpt: “...Despite these efforts, the financial system is still working against economic recovery. One major reason is the problem of “legacy assets” – both real estate loans held directly on the books of banks (“legacy loans”) and securities backed by loan portfolios (“legacy securities”). These assets create uncertainty around the balance sheets of these financial institutions, compromising their ability to raise capital and their willingness to increase lending.”
“Despair over financial policy,” Paul Krugman, NYT, 03-23-09.[NY Times]
- Excerpt: “...In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem…”
“.S. Lays Out Plan to Buy Up to $1 Trillion in Risky Assets,” NYT, 03-23-09.[NY Times]
- Excerpt: “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.”
“Treasury Unveils Details of Plan to Relieve Banks of Toxic Assets,” Washington Post, 03-23-09.[Washington Post]
- Excerpt: “...If investors select assets wisely, and the assets prove to have good value over the long run, the loans will be repaid, and the hedge fund and Treasury Department split the remaining profits in proportion to their original investment. If the investors choose poorly, or the assets fall significantly in value, the government shares in the initial loss and potentially is required to spend additional money to cover the loan guarantees…”
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