Felicia Muftic: Toxic asset plan a hopeful step toward economic recovery
March 29, 2009
The toxic asset plan put forth by Treasury Secretary Timothy Geithner was complex, clever, controversy avoiding, capitalistic and confidence building. It is cheaper than Plan B the left would prefer and avoids the catastrophe of the right’s do-nothing, Herbert Hoover alternative.
It is creative. The only time such an approach has been tried was two weeks ago with a similar, smaller plan (tagged TALF by its abbreviations) to get consumer credit lending for credit cards, student and auto loans going again. The plan presented by Geithner targeted investment in securities and bonds that were backed by mortgages/assets that had gone bad due to foreclosure or other failures.
The purpose of the Geithner plan is to provide a method to get the toxic assets off banks’ books so they would feel more able to loan money again.
The complexity of the plan makes it hard to sum up in an understandable nutshell. Last fall’s $700 billion TARP bailout was supposed to provide money for the government to buy those toxic mortgage assets from the banks so the credit markets would unfreeze and start lending again. Given the difficulty of doing so, then Treasury Secretary Henry Paulson decided it would be more expedient just to infuse half of the TARP funds into the banks capital kitties to keep them from going over the abyss . While it may have saved us from a total financial meltdown, it did nothing to unfreeze credit. Banks saw their balance sheets improve enough to put them into a zombie state, treading water until the toxic asset loans were dealt with.
Here was the controversy last fall that became the stumbling block to Paulson’s original plan: If the government were to buy the bad loan paper and investments from the banks, what should the price charged the government and taxpayers be? Should it be marked at the full price the bank originally paid for the asset? Should it be the much lower current value of that investment after the crash? And how should that be determined? From the taxpayer’s standpoint, the latter was preferable because it was a much lower price. From the bank’s standpoint, they wanted the full original price, of course, or if not that, some price it would be worth in the future. That is the essence of the “mark to market” controversy.
Geithner’s plan is clever. It lets the free market figure out the value and sidesteps the whole issue of the Government determining the value by putting those assets up for sale. The problem is who in their right mind would want to buy the toxic assets? To make the assets worth something, the Government is attempting to attract buyers by offering them a good deal they can’t refuse. The Government, in effect, will loan investors 85 percent of the purchase money at a low rate to buy the assets, and the investor will only have to put up 7.5 percent and the government will provide the investor a matching of another 7.5 percent. If the real estate market improves, both taxpayers and the asset purchasers will come out ahead as those assets are sold off at a profit.
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If it doesn’t, the investor loses his money and the government is left holding the bag. Where is the money coming from to loan the investors and to cover the risks? It will come from the remainder of the TARP money and from the Federal Reserve. It avoids having the government buy up the entire toxic paper itself at full price and lets the private sector shoulder some of the financial burden and risk. It also is politically clever because it avoids having to take further bank bailouts to an out-of-control, off-the-wall Congress for approval.
Here is where it is capitalistic. It lets the market determine the value of the assets. It lures private sector capital to participate. It avoids nationalizing banks by giving them a blood transfusion in the form of taking their bad and worthless assets off their books. The question then becomes, will the banks start loaning again?
The key will be the confidence investors feel in participating.
There are two elements. Will private equity types and hedge fund managers step forward to partner with the government? Or will they hold back, fearing a lynch mob will come after them if they make a profit and reward their managers in return? Wall Street was the first to give their vote of confidence last week, a hopeful sign of things to come since their participation is crucial.
If the Geithner plan fails, it is on to Plan B. Nationalize some banks, close others, and/or buy toxic assets at full value. If B fails, we are back to 1933 ” a full blown catastrophe lasting many years.
” To read more commentary by Felicia Muftic, visit her blog at http://apps.skyhidailynews.com/utils/blogs/index.php?id=Blog:8d6b33f2-2f20-43b9-99f2-b83d9f6e3853 or visit her Web site, http://www.mufticforum.com