Treasury Secretary Timothy Geithner Details His Toxic-Asset Strategy, the Public-Private Investment Program - WSJ.com

Treasury Secretary Timothy Geithner Details His Toxic-Asset Strategy, the Public-Private Investment Program - WSJ.com

Here are some snippets from today's announcement of the Treasury's plan.

"Now all Mr. Geithner has to do is find private investors willing to "partner" with the feds (Congress!) to bid for those rotten assets, coax the banks to sell them at a loss, and hope that the economy doesn't keep falling lest taxpayers lose big on their new loan guarantees."

"Don't be fooled because Treasury isn't going to Capitol Hill for more cash. The Obama Administration is instead leveraging the balance sheets of the Federal Reserve and Federal Deposit Insurance Corp., which will lend to the new public-private entities to buy the toxic assets.

In the case of the FDIC, it will lend at a debt-to-equity ratio of 6-to-l to the buyers. This means, according to the Treasury example, that the FDIC would guarantee 72 cents in funding for an asset purchased for 84 cents on the dollar. The feds and private investors would each put up six cents in capital. If the asset rises in value over time, the taxpayer and investors share the upside. If it falls further, then the taxpayers would absorb by far the biggest chunk of the losses. Better hope the recovery really is, as the White House says, just around the corner."

Doesn't leave you jumping for joy does it, but the market reacted in a tremendous way to this announcement (I'm sure some of the upside also had to do with the fact that the Feb housing numbers looked much better than expected).

I'm trying to absorb what type of bet Geithner is making and then handicap this bet by understanding the risks that we the taxpayers will be taking on.

I like this guy's explanation of what went south over the last ten years or so with the housing bubble and then the collapse over the last two years or so.





Now that we have an understanding of what kind of mess we are in, the Treasury is planning on helping those banks that are holding these toxic assets that may never get payment. So Geithner's plan does the following:

Under a typical transaction, for every $100 in soured mortgages being purchased from banks, the private sector would put up $7 and that would be matched by $7 from the government. The remaining $86 would be covered by a government loan. So we the tax payer's essentially loan the government and the private investor's money, not sure at what rate the loan is given, but its given at a 6:1 debt/capital ratio. This loan helps them purchase these bad assets off the banks for a given price. Right now, there is going to be some mechanism to determine the price of these assets. I think this is going to occur under the FDIC watch, and then fund managers will be elected to manage these funds to ensure that we are buying the assets at a good price with hopes of a strong return.

The pros I see:

1. By providing up to a Trillion dollars (how the heck did we start thinking that a trillion dollars can be thrown around so easily) to the banks, it should really start incentiving these banks to start lending and making money on their loans.
2. Then as the loans start to go out, people may start buying homes again pushing up demand for homes and pushing up prices.
3. Hopefully, the economy starts to pick up as people's confidence comes back and jobs start to increase with the other TARP programs and with more capital available in the market.
4. Then the private investors and the treasury start to make profits in their investments into these toxic assets and the FDIC starts to get their loan back so the US Taxpayer gets money back with their profits and whatever the loan rate was.

The risks I see are:

1. We don't know what the banks are going to sell, with AIG, I think all private industries are very wary of working with the government because then the public essentially can react in a very negative way if anything looks unpleasant. Let's say that the housing market turns around, the bad assets all of the sudden become very strong house values and these private investors start making billions of dollars off the tax payer's money. Should they keep all of these huge gains or give some back?
2. How are the prices of these assets going to be determined, its not like there are thousands of people trying to gauge the risk of these assets, the FDIC will be doing that analysis, and its not a free market, so there seems to be a lot of unknowns around how much money the bad assets are going to be need to be purchased for. If the price is too high, then any failure puts the tax payer money at a huge risk, if its too low, then the banks are not going to take them off their balance sheets and try to wait out the storm in hopes that the underlying assets will return to higher prices.
3. Will the economy turn around anytime soon. What happens if all of this doesn't work and the economy turns south, the job losses continue, the house values continue to drop, and investments from foreign entities dry up? Then the U.S treasury has no money and the underlying assets that were invested into are worthless. Its back to the printing press and China is really starting to put some strong pressure saying that they are not very happy with their investments being put at risk with all of this mess.

At this point, I don't know what alternatives there are out there, let's hope that we have bottomed out and the economy starts to really pick up with these banks starting to lend money again. Its time for the innovators to come out and start building strong businesses that will hire more US employees, and start reving up the engine again.