WASHINGTON — Financial markets roared ahead Monday as investors reacted with near-euphoria to the Obama administration’s new trillion-dollar plan to stabilize banks by relieving them of their troubled assets and risky loans.
Even as markets exulted, conflicting interests among participants in the program — banks, investors and taxpayers — were emerging, leaving in doubt the fate of a program meant to revive bank lending and in turn reinvigorate the overall economy.
Some banks are resisting government pressure to sell assets at prices they think will be too low. And despite the risk of an outcry from Congress, the Treasury this past weekend made the program more attractive to private investors, according to industry and some government officials.
In the short run, the rollout of the plan gave a much-needed boost to the administration and beleaguered Treasury Secretary Timothy Geithner, as officials on Wall Street and Washington in general spoke favorably of the plan. The Dow Jones industrial average shot up nearly 500 points.
“The policymakers definitely have the right ideas in their head right now, but whether they can execute it I don’t know,” said Daniel Alpert, managing director of Westwood Capital, a boutique investment bank.
The Obama administration is now preparing its next move, planning this week to send legislation to Congress granting the government powers to seize troubled nonbank financial companies whose collapse would threaten the broader economy, according to three sources familiar with the matter.
Administration officials said the proposed authority, for instance, would have allowed them to seize American International Group last fall and wind down its operations at less cost to taxpayers. Geithner is expected to argue for the new powers at a hearing today on Capitol Hill.
The new Public-Private Investment Program, which Geithner announced Monday, includes programs to buy up real-estate-related loans and securities backed by those loans.
It will combine $75 billion to $100 billion in financial rescue funds already approved by Congress with investments from private investors, loan guarantees by the Federal Deposit Insurance Corp., and loans from the Federal Reserve to buy up to $1 trillion in real-estate-related assets.
The idea is that banks are unwilling to lend money in part because they fear further losses on past loans now stuck on their books.
Government officials said they hope that introducing new buyers will help set a floor for asset prices and stabilize the broader financial system by removing troubled assets from financial firms.
But the initiative leaves the Treasury’s financial rescue fund nearly tapped out, and administration officials worry that they might be unable to get more money.
Geithner’s credibility with Congress was at a low ebb after the outcry last week over bonuses paid to executives of American International Group. Congressional leaders say it would be difficult to pass a law giving the Treasury any further funds for financial rescues.
Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, suggested that a successful rollout of the public-private investment fund could change the tenor on Capitol Hill.
“What they’re trying to do now is avoid a showdown” between the administration and Congress over more bailout money, he said. “If these things are successful, then I think there would be some more funding down the road.”
The response from investors Monday was supportive. Bill Gross, co-chief investment officer of Pimco, the nation’s largest bond investor, said his firm is eager to participate and that the program is a “win-win-win” policy.
However, some analysts and senior government officials fear that taxpayers might be giving up too much to the investors — including potential double-digit-percentage returns.
Details of the rescue
The Obama administration’s plan to finance purchases of as much as $1 trillion in toxic assets from banks will include programs supported by the Treasury Department’s bailout fund, the Federal Reserve and the Federal Deposit Insurance Corp. Here is a look at how they will operate.
Public-Private Investment Program:
The umbrella organization that will support the effort to entice private investors to join with the government to buy troubled assets. The administration plans to commit $75 billion to $100 billion from the government’s $700 billion bailout program to support $500 billion in troubled asset purchases with the potential to expand to $1 trillion.
Troubled Mortgage Loans:
The FDIC, which insures deposits at the nation’s banks, would operate auctions of troubled mortgage loans and then provide financing to the winning bidders. Under an example provided by the administration, the FDIC loan would cover 86 percent of the purchase price of the troubled mortgages with the Treasury’s bailout fund contributing 7 percent and the winning private investor bidder contributing the remaining 7 percent.
Term Asset-Backed Securities:
The Treasury and the Federal Reserve announced they were expanding the Term Asset-Backed Securities Loan Facility, or TALF, beyond its goal of boosting consumer debt in auto loans, credit cards and student loans. The facility, which has the capacity of supporting $1 trillion in loans, will be expanded to cover securities backed by residential and commercial real estate and other types of asset-backed mortgages. Five asset managers will be chosen by Treasury to compete for purchases of troubled asset-backed securities with financial backing from Treasury and TALF. The assets would be held in public-private investment funds.
The Associated Press
Q&A
Q: Toxic assets? Sounds dangerous. And they sound more like liabilities than assets. What are they, and how many are there?
A: Toxic assets are, mostly, the investments backed by risky subprime mortgages that are held by the larger U.S. banks and that have lost value. They hang like shackles from the banks’ feet, dragging down their balance sheets and their fortunes.
It started in early 2007, when the mortgage crisis hit and defaults on subprime home loans, those made to borrowers with tarnished credit histories, began to climb. That gutted the value of the mortgage-backed securities — subprime mortgages bundled together and sold on Wall Street to investors — held on the books of the big banks.
When the banks — like Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. — started writing down the value of the securities, they reported billions of dollars of losses. Their capital eroded and they didn’t have the money to make loans. Credit dried up. Banks large and small foundered and failed. There are about $2 trillion in bad assets on banks’ books.
Q: So why is this plan just now coming out?
A: When the financial crisis raged in September, the Bush administration first looked to have the government buy up hundreds of billions of dollars in banks’ toxic assets. That raised questions of how to price them. They are complex and no one, not even banks, knows how much they are worth.
Investors were loath to touch the assets — although they could fetch higher prices in the future after the housing market recovers.
If the government paid too little for the assets — that is, close to recent sales prices of only a few cents on the dollar — it could potentially wipe out the net worth of many banks and set off a wave of bank failures. On the other hand, if Uncle Sam paid too much, he could risk costing taxpayers hundreds of billions of dollars that they wouldn’t likely get back.
So the Bush officials abandoned the idea. Instead, they opted to use hundreds of billions in rescue funds mostly to directly inject capital into banks to get them to lend again.
Now we’re back to buying up toxic assets. The idea behind the Obama plan is that private investors would help jump-start a robust market for the securities, potentially lifting their value because they could be sold — and establishing a logical price for them.
Q: Are there other toxic assets, besides mortgage-linked securities, that are involved here?
A: The main focus for the new program is on assets tied to residential and commercial mortgages. But the Treasury Department said that could evolve, based on market demand, to embrace other types of assets. That could include securities backed by credit card debt, student loans or auto loans, which have suffered in recent months from rising defaults and have been aided by lending from the Federal Reserve.
Marcy Gordon, The Associated Press
Two Views
Two executives familiar with the government’s plan to purchase troubled bank assets were supportive.
Sue Allon, CEO of Allonhill, a firm that monitors risk in mortgage-backed securities:
“There are $1.2 trillion of nonperforming loans held by banks, and more than that in securitized loans that could be traded. Investors are holding themselves and loan sellers to a much higher standard of disclosure and integrity now than they did during the pie-eating contest we witnessed a couple of years ago. Geithner’s plan is the first step in returning the market to normalcy. When the market does come back to life, my hope is that past mistakes won’t be repeated.”
David Maney, chairman of Headwaters MB LLC, a Denver investment bank.
“Today, it seems that Secretary Geithner has suggested a reasonable road that does in fact seem likely to lead out of the dark woods. The fact that Nobel-winning gloom economist Paul Krugman hates it and the capital markets seem to love it means that it is almost certainly a workable plan. It should help lead the credit markets and the U.S. and the world out of the forest.”
Compiled by Aldo Svaldi, The Denver Post
