Three-Pronged Approach To Banks' Toxic Assets Revealed

Details of a three-pronged approach to relieve financial institutions of 'toxic' assets will be revealed by the U.S. Treasury Department as early as Monday, the WSJ and NYT report. Details are expected relating to the public-private investment fund in particular, part of the Financial Stability Plan first laid out by U.S. Treasury Secretary Tim Geithner on February 10. (As we previously reported, the government established a website, www.financialstability.gov, with information on the plan, see especially the Fact Sheet announced on Feb. 10, and watch for updates on that site.) The three-pronged plan, according to Deborah Solomon and Damian Paletta in their article, U.S. Sets Plan for Toxic Assets (WSJ), will include:

  • creating an entity, backed by the Federal Deposit Insurance Corp., to purchase and hold loans.
  • expand[ing] a Federal Reserve facility to include older, so-called "legacy" assets. Currently, the program, known as the Term Asset-Backed Securities Loan Facility, or TALF, was set up to buy newly issued securities backing all manner of consumer and small-business loans. But some of the most toxic assets are securities created in 2005 and 2006, which the TALF will now be able to absorb.
  • establish[ing] public-private investment funds to purchase mortgage-backed and other securities. These funds would be run by private investment managers but be financed with a combination of private money and capital from the government, which would share in any profit or loss.

"All told, the three efforts are designed to unglue markets that have seized up as investors have stood on the sidelines," state Solomon and Paletta.

However, they add, "One big problem is that many of these assets no longer trade, which means it's very hard to put a price on them. Banks are unwilling to sell at too low a price, and investors are unwilling to take the risk. The Treasury's hope is that introducing private investors will help create market prices. Earlier attempts to have the government set the prices foundered because too high a price would have hurt taxpayers and too low a price would have hurt banks. Private investors, by contrast, could set a market price because they are unlikely to overpay and banks are unlikely to undersell."

Similarly, Edmund L. Andrews, Eric Dash and Graham Bowley report in Toxic Asset Plan Foresees Big Subsidies for Investors (NYT) that, "Risk-taking institutional investors, like hedge funds and private equity funds, have refused to pay more than about 30 cents on the dollar for many bundles of mortgages, even if most of the borrowers are still current. But banks holding those mortgages, not wanting to book huge losses on their holdings, have often refused to sell for less than 60 cents on the dollar. The result has been a paralyzing impasse. Banks, unwilling to sell their loans at fire-sale prices, have had less capital available to make new loans. Mortgage investors, unable to leverage their investments with borrowed money, have been unwilling to pay more than fire-sale prices. To break that impasse, the government’s crucial subsidy is meant to provide investors with the kind of low-cost financing that has been utterly unavailable in today’s credit markets."

"To entice private investors like hedge funds and private equity firms to take part," write Andrews, Dash and Bowley, "the F.D.I.C. will provide nonrecourse loans — that is, loans that are secured only by the value of the mortgage assets being bought — worth up to 85 percent of the value of a portfolio of troubled assets. The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money, according to industry officials. Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent. The government would receive interest payments on the money it lent to a partnership and it would share profits and losses on the equity portion of the investment with the private investors."

In related news, Federal Reserve Board Chairman Ben S. Bernanke and FDIC Chairman Sheila C. Bair made keynote speeches earlier this week to the Independent Community Bankers of America (ICBA). Read highlights of their remarks here.

In related news, in the run-up to the G-20 meeting set to begin April 2, we see action on both sides of the Atlantic (and Pacific). See our separate post today, U.K. FSA Issues The Turner Review, which contains recommendations relating to the global banking crisis.

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FEI Financial Reporting Blog provides highlights from SEC, PCAOB, FASB, IASB, and other regulatory news, including reporting under Sarbanes-Oxley Sect 404. It is written by Edith Orenstein, Director of Technical Policy Analysis at FEI

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