The Treasury Department’s long-delayed and eagerly awaited plan to buy as much as $1 trillion in toxic assets that are clogging banks’ balance sheets and crippling their ability to make new loans will be introduced as early as next week – according to the NYT (The WSJ said it could come as soon as Monday, but Treasury officials would not confirm that).
Obviously, the uproar over the AIG’s bonuses has not stopped the current administration from moving ahead with plans to jumpstart the resumption of normal lending.
The new toxic asset plan, which from initial indications seems to be in the right track in terms of its framework and hopefully its success, (always depending here on the private-sector’s willingness to offer its support at an especially tough time) addresses critical points like government’s planning on how to share the risk with private investors or arrive at a fair price for the assets that would neither trick/deceive taxpayers nor harm the banks.
The new plan will involve three separate approaches that are all aimed at attracting institutional investors by offering abundant loans and generous terms.
First, “the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell.”
Secondly, “the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money.’
Third, “the Treasury plans to expand lending through the Term Asset-Backed Secure Lending Facility, a joint venture with the Federal Reserve.”
The Treasury plans to contribute up to $100 billion in new capital to the effort, although the possibility of that amount expanding down the road, remains highly probable. In addition, the FDIC would provide guarantees against losses on a pool of loans that a bank wants to sell. The program could guarantee as much as $500 billion in loan investments.
The three efforts are designed to unglue markets that have seized up and hopefully clear the way for an amelioration and unclogging of the credit markets. However, Calif. Democratic Rep. Brad Sherman, who sits on the House Financial Services Committee, expressed skepticism about the plan’s prospects.
“It looks like a scheme in which the taxpayer takes all the risk and the hedge funds get almost all the profits,” Sherman told Reuters.
But the key protection for taxpayers, notes NYT, is that “the private investors will bid in auctions against each other for the assets. As a result, administration officials contend, the government will be buying the troubled loans of the banks at a deep discount to their original face value. Because the government can hold those mortgages as long as it wants, officials are betting the government will be repaid and that taxpayers may even earn a profit if the market value of the loans climbs in the years to come.”
While institutional investors so far have refused to pay more than about $0.30/on the dollar for many bundles of mortgages, even though most of the borrowers are still current, with so little donwside risk – hedge funds and private equity firms can pay higher market price for the toxic assets. At the same time, many of these assets no longer trade which makes their pricing process very hard and complicated. The Treasury’s hope however, is that introducing private investors will help create market prices.
I’m sure the plan will receive strong criticism since different people have their own preference. Still, the reality is that unless we fix the housing market and banking system, which acutely involves getting rid of “toxicity”, you guarantee to have a deep and a very long recession.