Obama Set to Detail New Program for Toxic Assets

The Obama administration may unveil new details of its anxiously awaited financial stability as early as Monday, shedding light on how it plans to deal with the thorny problem of making a market in the toxic assets that have plagued the balance sheets of big financial firms.

AP

The plan breaks into three parts: The creation of a new government entity--entailing some aspects of a so-called "bad bank"--to handle some of the toxic assets; more details on the private-public partnership funds that were first outlined five weeks ago; and the expansion of a recently launched Federal Reserve lending facility, known as the TALF, according to an industry source.

The total cost of the measures, as well as the funding mechanisms involved, are not entirely clear at this time, but about $100 billion is expected to come from the second $350 billion tranche of the TARP.

Treasury Secretary Timothy Geithner has said the public-private initiative could cost between $500 billion and $1 trillion and involve loans, guarantees and outright purchases. Its unclear, however, if that would cover the new government entity and Term Asset-Backed Loan Facility components.

Treasury spokesman Isaac Baker Saturday declined to comment until details of the plan are announced. Aspects of the plan, however, have been leaking out to various news organizations, including CNBC, over the past few days.

The timing of the announcement remains uncertain, according to the source, because of the recent public uproar over the latest disclosures about bonus payments at AIG , which has received $182 billion in government aid. The Obama administration was reportedly working toward announcing the details of the toxic asset plan last week before the latest flap over executive compensation.

The compensation matter now appears to be an issue for both the government and the private sector as they consider a new dimension to what may be considered something of a symbiotic working relationship.

The government has been imposing increasingly strenuous terms on firms participating in financial aid programs, from limits on executive compensation and other spending areas to lending and transparency requirements. At the same time, financial firms have begun to balk at the government’s conditions, with some saying they would return aid money and others indicating they no longer planned to participate.

That dynamic could get even trickier, as the new measures are likely to include a more direct commingling of money and interests. The public-private investment partnership, PPIFs, are expected to use a combination of private and federal funding to purchase the bad assets through newly created investment funds run by private sector firms.

"We are worried about counter-party risk," a source said. "The US government comes to the table with a whole lot of counter-party risk."

Meanwhile, the government is worried about increased taxpayer backlash over what has been seen in some quarters as corporate welfare as well as the amount of money it is devoting.

• Wall Streeters Face Bitterness—And Shock

Early efforts started under the Bush administration featured direct investment, on a dollar-for-dollar basis, so to speak, without any leveraging. Some $350 billion was used to inject capital into needy firms in exchange for preferred stock.

"Leverage it up. Guarantee the money," said the industry source. " I don't think Congress is in any mood to approve more money right now."

The government then started to use an insurance-loan guarantee model, which leveraged a lesser amount of cash. That model will play a significant role in the new initiatives, which are meant to tackle some $1 trillion to $2 trillion in bad or toxic assets. Those include illiquid and non-performing assets in the form of mortgage-backed securities and other debt instruments.

The private-public investment funds appear to be the Obama administration’s best idea to solve the riddle of pricing the assets. By involving private firms, the thinking goes, the more likely buyers and sellers can agree on a fair price, and thus begin to make a market. Previously there had been concern the government would over-pay for firms that otherwise would sell at fire-sale prices.

The PPIFs are also intended to tap what is thought to be a wealth of private capital which has been sitting on the sidelines during the financial crisis, waiting for the right opportunity.

To encourage that, the government will provide low-cost financing as well as some sort of insurance to protect their investment. Both groups will benfit from any appreciation in the investment.

© 2009 CNBC.com