US Treasury Details Toxic Asset Plan

The U.S. Treasury Monday provided details on its public-private plan to sop up bad assets now choking bank balance sheets. Following is a look at the plan:

Overview

The U.S. Treasury will provide $75 billion to $100 billion to seed the program. The money would come from the $700 billion financial rescue fund Congress approved in October.

The Treasury plans to leverage that money to buy $500 billion worth of toxic assets with financing from the Federal Deposit Insurance Corp, a U.S. bank regulator, and the Federal Reserve, with the potential to reach to up to $1 trillion.

Reaching the $1 trillion level without seeking new funding from Congress will depend on investor interest in the program and which parts of it prove more popular. The plan relies on existing legal authority, so the Obama administration does not need congressional approval to start it.

By bringing in private investors, the government hopes to jump-start market mechanisms to establish benchmark prices for these assets. The plan will not impose executive pay restrictions on passive private investors in the program.

"Legacy" Loans Program

Treasury plans to seed a number of public-private investment funds that would combine taxpayer money with private capital to buy distressed "legacy" loans from banks.

These investment funds could purchase these loans by raising FDIC-guaranteed debt. The agency will offer up to a 6-1 debt-to-equity leverage ratio for these loans. So if investors and the Treasury each contribute $1 billion in equity to a fund, that entity can raise up to $12 billion in FDIC financing to purchase $14 billion in loans.

Under this part of the program, banks would approach the FDIC with a pool of loans they want to sell. The FDIC would offer financing and Treasury would partner with private investors to bid in auctions for the loans.

The auction and promised leverage determines the price for the assets. The Treasury could provide anywhere from 50 percent to 80 percent of the equity capital.

Obama administration officials said this part of the program could make up the largest portion of the asset purchases and the distressed loans are the largest problem for banks that is hampering their lending.

"Legacy" Securities Program

Public-private funds also will get opportunities to buy so-called "legacy' securities with a combination of private and government capital, possibly levered up by the government.

There are two basic approaches:

• Under one, the Federal Reserve will provide financing by expanding its Term Asset-Backed Securities Loan Facility, or TALF. The TALF, which is now a $200 billion program, will be expanded up to $1 trillion and will begin accepting older residential mortgage-backed securities that were once rated Triple-A and commercial mortgage-backed securities and asset-backed securities that are Triple-A as collateral for loans.

These securities will be given a valuation "haircut" larger than other TALF assets because of their riskier nature.

Currently, the TALF offers loans only against new or recently issued Triple-A rated asset-backed securities, with a narrower pool of securities acceptable as collateral, such as those backed by car loans, credit card debt and student loans.

• Under the second approach, the Treasury will initially hire five investment managers to raise capital with a dollar-for-dollar public match. These fund managers would then be able to access senior debt from the Treasury equal to 50 percent of the combined capital to buy securities.

The government and private investors would share equally in gains and losses from the program, and each dollar in private equity will leverage two dollars in public funds.

Applicants for these investment management positions must be U.S.-based firms able to demonstrate they can raise at least $500 million in private capital and have at least $10 billion in eligible assets under management. Applications for the positions must be submitted by April 10, and winners will be informed of the decision by May 1.

Winners will have a "limited period of time" to raise at least $500 million in private capital.

The Treasury hopes that by competing with each other, the partnership would help create a price for legacy securities that are not currently trading, while helping to ensure the government does not pay too much.

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