US Unveils Complex Plan To Deal With Toxic Assets

The US Treasury Monday revealed details of a highly-anticipated plan to set up public-private investment funds that will buy up to $1 trillion in troubled loans and securities at the heart of the financial crisis.

Market reaction was positive with stocks—especially those of financial firms—risingaround the globe, while the dollar was stable.

Financial Crisis
Financial Crisis

The Treasury’s complex plan to use private funds to purchase toxic assets uses low-cost government financing, government guarantees and government equity as incentives.

The plan has two programs—one to purchase securities, the other to purchase loans from banks.

The initial goal is to "generate $500 billion in purchasing power," as the government put it in its plan fact sheet, but the cost could reach $1 trillion. About $75 billion to $100 billion of the government funding will come from the second tranche of the TARP.

  • CNBC Interview With Treasury Secretary Geithner To Air at 2 pm ET

The Obama administration's latest plan comes amid a growing taxpayer backlash about aid to Wall Street, as well as what many consider exorbitant executive pay.

Administration officials Monday addressed those concerns, emphasizing that public and private money was being used together.

"We're sharing in a partnership form," said White House economist Austan Goolsbee on CNBC. "If the private sector profits, then the government profits."

Public and lawmaker fury over the bonuses, and efforts on Capitol Hill to claw them back, have made many investors skittish about partnering with the government. But the Treasury specified that private partners in its latest effort to revive credit markets will not face tough executive pay restrictions.

How The Plan Works

In one initiative, the government will create up to five public-private partnerships, run by approved asset managers, with the government and private firms each providing 50 percent of the capital. The structure is meant to create a market for the troubled assets, which have been difficult, if not impossible, to price since the financial crisis first erupted 18-months ago.

Toxic assets clogging the balance sheets of financial firms could total $2 trillion and generally fall into two broad categories—illiquid or non-performing

The FDIC will oversee the program and will also provide financing along with the Treasury.

Under the PPIF, participating firms will identify the assets, usually as a pool of loans, which will be auctioned off to the highest bidder. The government will determine how much funding is necessary to enable the transaction, with leverage not to exceed a 6-to-1 debt-to-equity ratio.

Though the toxic assets plan has been eagerly-awaited by Wall Street, the Obama administration was careful Monday not to raise expectations unduly. Goolsbee said the latest initiative was "one key brick in what's been a multiple brick process, trying to put the house back together."

The government's Financial Stability Plan also includes a $75 billion foreclosure mitigation plan, up to $1 trillion in support for consumer and business lending and a capital-for-equity swap plan.

The plan released Monday will also "create a lending program that will address the broken markets for securities tied to residential and commercial real estate and consumer credit." That will be done through the the previously announced Term Asset-Backed Securities Facility, TALF, which was launched last week by the Federal Reserve. The Fed will make "non-recourse loans" to investors to fund purchases of certain assets.

Under this program, the Treasury will partner with private firms in buying mortgage- and asset-backed securities with a triple AAA rating.

When he first mentioned public-private investment funds in February, Geithner laid out the proposal in such scant detail that markets sank on fears there was no clear-cut plan for rescuing a banking system beset by poorly performing mortgage and other assets left over from a housing boom that went bust.

Industry reaction to the long-awaited plan was positive.

"The partnership between public and private institutions is a great way to help restore liquidity in the market," said the Financial Services Roundtable, which represents 100 of the nation's largest integrated financial services firms. "It is encouraging to see Treasury creating unique ways of stimulating the economy while protecting the taxpayer."

"This is a tremendously positive step toward implementing the Troubled Assets Relief Program as originally intended. Clearing toxic assets off of banks' balance sheets is an essential first step if we are to turn the corner on this recession," the Securities Industry and Financial Markets Association said in a statement.