Treasury Secretary Timothy Geithner unveiled details of a new plan to lure private investors into helping cleanse U.S.banks of up to $1 trillion in toxic assets.
Here is the official U.S. Department of the Treasury
press release:
The Financial Stability Plan - Progress So
Far: Over the past six weeks, the Treasury
Department has implemented a series of initiatives as part of its Financial
Stability Plan that - alongside the American Recovery and Reinvestment Act - lay
the foundations for economic recovery:
- Efforts to Improve Affordability for Responsible Homeowners:
Treasury has implemented programs to allow families to save on
their mortgage payments by refinancing, assist responsible homeowners in
avoiding foreclosure through a loan modification plan, and, alongside the
Federal Reserve, help bring mortgage interest rates down to near historic lows.
This past month, the 30% increase in mortgage refinancing demonstrated that
working families are benefiting from the savings due to these lower
rates.
- Consumer and Business Lending Initiative to Unlock Frozen Credit
Markets: Treasury and the Federal Reserve are expanding the TALF
in conjunction with the Federal Reserve to jumpstart the secondary markets that
support consumer and business lending. Last week, Treasury announced its plans
to purchase up to $15 billion in securities backed by Small Business
Administration loans.
- Capital Assistance Program: Treasury has also
launched a new capital program, including a forward-looking capital assessment
undertaken by bank supervisors to ensure that banks have the capital they need
in the event of a worse-than-expected recession. If banks are confident that
they will have sufficient capital to weather a severe economic storm, they are
more likely to lend now - making it less likely that a more serious downturn
will occur.
The Challenge of Legacy Assets: Despite
these efforts, the financial system is still working against economic recovery.
One major reason is the problem of "legacy assets" - both real estate loans held
directly on the books of banks ("legacy loans") and securities backed by loan
portfolios ("legacy securities"). These assets create uncertainty around the
balance sheets of these financial institutions, compromising their ability to
raise capital and their willingness to increase lending.
- Origins of the Problem:The challenge posed by
these legacy assets began with an initial shock due to the bursting of the
housing bubble in 2007, which generated losses for investors and banks. Losses
were compounded by the lax underwriting standards that had been used by some
lenders and by the proliferation of complex securitization products, some of
whose risks were not fully understood. The resulting need by investors and banks
to reduce risk triggered a wide-scale deleveraging in these markets and led to
fire sales. As prices declined, many traditional investors exited these markets,
causing declines in market liquidity.
- Creation of a Negative Economic Cycle: As a
result, a negative cycle has developed where declining asset prices have
triggered further deleveraging, which has in turn led to further price declines.
The excessive discounts embedded in some legacy asset prices are now straining
the capital of U.S. financial institutions, limiting their ability to lend and
increasing the cost of credit throughout the financial system. The lack of
clarity about the value of these legacy assets has also made it difficult for
some financial institutions to raise new private capital on their own.
The Public-Private Investment Program for Legacy
Assets
To address the challenge of legacy assets, Treasury - in
conjunction with the Federal Deposit Insurance Corporation and the Federal
Reserve - is announcing the Public-Private Investment Program as part of its
efforts to repair balance sheets throughout our financial system and ensure that
credit is available to the households and businesses, large and small, that will
help drive us toward recovery.
Three Basic
Principles: Using $75 to $100
billion in TARP capital and capital from private investors, the Public-Private
Investment Program will generate $500 billion in purchasing power to buy legacy
assets - with the potential to expand to $1 trillion over time. The
Public-Private Investment Program will be designed around three basic
principles:
- Maximizing the Impact of Each Taxpayer Dollar:
First, by using government financing in partnership with the FDIC
and Federal Reserve and co-investment with private sector investors, substantial
purchasing power will be created, making the most of taxpayer resources.
- Shared Risk and Profits With Private Sector Participants:
Second, the Public-Private Investment Program ensures that private
sector participants invest alongside the taxpayer, with the private sector
investors standing to lose their entire investment in a downside scenario and
the taxpayer sharing in profitable returns.
- Private Sector Price Discovery: Third, to reduce
the likelihood that the government will overpay for these assets, private sector
investors competing with one another will establish the price of the loans and
securities purchased under the program.
The Merits of This Approach: This approach
is superior to the alternatives of either hoping for banks to gradually work
these assets off their books or of the government purchasing the assets
directly. Simply hoping for banks to work legacy assets off over time risks
prolonging a financial crisis, as in the case of the Japanese experience. But if
the government acts alone in directly purchasing legacy assets, taxpayers will
take on all the risk of such purchases - along with the additional risk that
taxpayers will overpay if government employees are setting the price for those
assets.
Two Components for Two Types of Assets: The
Public-Private Investment Program has two parts, addressing both the legacy
loans and legacy securities clogging the balance sheets of financial firms:
- Legacy Loans:The overhang of troubled
legacy loans stuck on bank balance sheets has made it difficult for banks to
access private markets for new capital and limited their ability to
lend.
- Legacy Securities:
Secondary markets have become highly illiquid, and are trading at
prices below where they would be in normally functioning markets. These
securities are held by banks as well as insurance companies, pension funds,
mutual funds, and funds held in individual retirement accounts.
