Aimed at financing purchases of illiquid real-estate assets.
The Obama administration unveiled its long-awaited plan to remove toxic assets from the books of the nation’s banks, betting that it can revive the US financial system without resorting to outright nationalisation.
The plan is aimed at financing as much as $1 trillion in purchases of illiquid real-estate assets, using $75 billion to $100 billion of the Treasury’s remaining bank-rescue funds. The Public-Private Investment Programme will also rely on Federal Reserve financing and Federal Deposit Insurance Corp debt guarantees, the Treasury said in a statement in Washington.
Barely two months after President Barack Obama took office, he and Treasury Secretary Timothy Geithner are staking much of the new administration’s economic credibility on the theory that removing the devalued loans and securities from banks’ balance sheets will help them start lending again and resuscitate the economy.
The Standard & Poor’s 500 Stock Index rose 3.6 per cent to 796.21 at 10.26 am in New York, and the S&P 500 Financials Index jumped 8.6 per cent. Yields on benchmark 10-year Treasury notes were down 1 basis point at 2.62 per cent.
Because the program depends on private investors stepping up, it may be weeks or months before it’s clear whether the approach will work. “You will start to see this buying up the assets” shortly after private asset managers are chosen by May, Austan Goolsbee, a member of the White House Council of Economic Advisers, said in an interview with Bloomberg Television.
Bush abandoned
Today’s announcement is the latest in a string of government attempts to end the worst financial crisis in seven decades; the Bush administration abandoned an earlier plan to buy the toxic securities in November. Obama officials still have to pick private asset managers and banks have yet to commit to selling their illiquid investments.
“The big question is what is the incentive for the banks to sell?” said Dino Kos, managing director at Portales Partners LLC in New York and former executive vice president at the New York Fed. “What is the incentive for a hedge fund to pay a price close to where the banks have it marked at?”
The announcement provides details on an initial strategy laid out by Geithner last month, which caused a slump in stocks because it lacked an explanation of how the effort would work. The S&P 500 index is still down about 10 percent since Geithner’s February 10 outline.
“This will allow banks to clean up their balance sheets,” Geithner told reporters at a news briefing in Washington. “There is no doubt the government is taking risk,” he added. “You cannot solve a financial crisis without the government assuming risk.”
Critics including Paul Krugman, a winner of the Nobel Prize for economics, advocate that the government take over banks loaded with devalued assets, remove their top management, and dispose of the toxic securities. Sweden adopted that approach in the 1990s. Krugman said in a New York Times opinion piece today that Geithner’s strategy won’t work because it “assumes that banks are fundamentally sound and that bankers know what they’re doing.”
Geithner said today that his plan was the best of a limited number of options, including leaving the illiquid assets on banks’ balance sheets or having the government itself buy them all, shouldering all the risk.
‘Not Sweden’
“We are the United States of America, we are not Sweden,” the Treasury chief said.
Half of the Treasury’s funds will go to a “Legacy Loans Program” that will be overseen by the FDIC. The Treasury would provide half of the capital going to purchase a pool of loans from banks, with private fund managers putting up the rest. The FDIC will then guarantee financing for the investors, up to a maximum of six times the capital, or equity, provided.
The FDIC, which has extensive experience disposing of devalued loans from taking over failed banks, will hold auctions for the pools of loans, which will be controlled and managed by the private investors with oversight by the FDIC.
A “broad array of investors are expected to participate in the Legacy Loans Program,” the Treasury said, encouraging insurance companies, pension funds and even individual investors to join in.
‘Legacy Securities’
The second half of the Treasury’s contribution will go to the “Legacy Securities Program.” The objective of the initiative is to generate prices for securities backed by mortgages that are no longer traded because investors have little confidence about the underlying value of the home loans.
Under this program, the Fed will expand an existing facility that provides financing for investor purchases of asset-backed securities. The Term Asset-Backed Securities Loan Program will be broadened to take on assets such as residential mortgage-backed securities that were originally rated AAA and sold by private banks.
The Treasury will also approve as many as five asset managers “with a demonstrated track record of purchasing legacy assets” that will buy the securities.
The managers will be given time to raise private capital and receive matching funds from the Treasury. They will also be able to get “senior debt” from the Treasury of 50 percent to as much as 100 percent of the fund’s capital.
Adding to the pressure on the administration is an unprecedented wave of populist anger over the rescue thus far, following the revelation that employees of American International Group Inc. got $165 million in bonuses after the insurer received taxpayer funds.
Bonus Outrage
On March 19, the House voted 328-93 to impose a 90 percent tax on employee bonuses paid by companies such as AIG and Fannie Mae that received more than $5 billion in taxpayer assistance. The Senate is considering similar legislation.
The backlash on Capitol Hill means private firms may think twice about taking part in Geithner’s public-private partnership, even though government financing will limit their risk and increase the potential of earning profits, David Kotok, chairman and chief investment officer of Cumberland Advisors Inc., in Vineland, New Jersey, said before today’s release.
Goolsbee expressed confidence that private investors will step up.
“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. Those couple of businesses are only in existence because the government has bailed them out.”
