Wall Street warms to ‘toxic assets’ plan
Geithner's plan aims to use public and private money to clean up $500 billion to $1 trillion in bad loans.
New York — More than six months after the financial crisis began, the US government has a detailed plan that strikes at the heart of the overarching problem with the economy: “toxic assets” sitting on banks’ books.
The government’s latest effort to try to help the troubled financial system involves setting up a mechanism by which the taxpayers and private investors buy those bad assets. The effort, announced on Monday by Treasury Secretary Timothy Geithner, transfers part of the risk to America’s taxpayers and the federal bank insurance system. It’s not clear how much money the government will ultimately need to commit to remove between $500 billion and $1 trillion in loans from the banks’ books.
But without the program, which quickly attracted interest on Wall Street, “the risk would be greater headwinds for the economy and deeper recession,” says Mr. Geithner.
While the Bush and Obama administrations had moved quickly since September to shore up banks in imminent danger of collapse, these “toxic assets” have remained on the books because the banks have been unwilling to sell them at deeply discounted prices. The Obama administration says it’s important to allow the banks to have the freedom to lend money and help get the economy moving again if the problem is to be solved.
Bounce in the markets
Geithner’s new program has been widely anticipated. On Feb. 10, he had announced a less specific bank bailout plan. A disappointed Wall Street sold off stocks, with the Dow Jones Industrial Average falling 382 points. By way of contrast, by Monday at midafternoon, the Dow had gained nearly 300 points.
Some large investors, such as Black Rock and PIMCO, issued statements to say they would become partners.
“This is perhaps the first win-win-win policy to be put on the table, and it should be welcomed enthusiastically,” said Bill Gross, PIMCO’s chief investment officer, in an interview with Reuters. “We intend to participate and do our part to serve clients as well as promote economic recovery.”
Some private economists also said the plan could work.
Bad assets of $1 trillion?
The Federal Reserve is now putting the banks through “stress tests” to determine how much additional capital they might need if the economy worsens. Bank analysts expect that the Fed, in the course of these examinations, will also get a better idea of the amount of bad loans in the banks’ portfolios. Mr. Zandi estimates the bad loans are now as much as $1 trillion.
Yet some analysts suggest it’s too early to know if the program will work to remove many of the legacy loans from the banks’ books. “I am skeptical, but hoping I am wrong,” says Douglas Elliott, a fellow at the Brookings Institution in Washington.
Will banks go along?
If there is a stumbling block, he says, it will be from the banks that are unhappy with the prices offered for their bad loans and securities. He estimates the assets to have lost between 30 cents to 60 cents on the dollar in face value. “In many cases the banks think the assets are worth more than the investors will pay,” he says. “They will take a big hit to bank capital if they have to mark them down.”
In an effort to persuade investors to pay more for the assets, the government has agreed to put a floor under the losses of 10 to 20 percent of what the investor puts up. In a briefing with reporters Monday, Geithner said the great risk is that investors will still not want to buy the assets, or, in his words, “the system will not take enough risk now.”
Some investors are concerned that Congress, still in an uproar over the bonuses at insurance giant and bailout recipient AIG, might impose some form of taxation on them if the deal appears too profitable. Last week, the House passed a 90 percent tax on bonuses given by companies who are receiving more than $5 billion from the taxpayers. In an effort to assuage investors, Geithner says there will be no compensation limits imposed.
In an opinion piece in Monday’s Wall Street Journal, he argued that his new program was a better idea than having the taxpayers buy the loans directly from the banks. “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,” he wrote.
He also said it would not work to just let the banks work the assets off their books over time, since it would could take a decade or more, similar to what happened to Japan in the 1990s.
It’s not clear if Geithner will have to return to Congress for additional funds. To start the program, most of the money – about $100 billion – will come from what is left of the $700 billion bailout fund. In addition, the plan counts on the Federal Deposit Insurance Corp. (FDIC), an independent agency of the government that backs bank deposits. “Turning to the private sector and the FDIC is an attempt to avoid Congress,” says Mr. Elliott.
Potential fund managers for the toxic-asset programs are supposed to apply to the government by April 10. The government will choose the managers by May 1.