"U.S. Bank Bailout to Rely in Part on Private Money
Wall Street helped produce the global financial and economic crisis. Now, as the Obama administration prepares to unveil a revised bailout plan for the banking system, policy makers hope Wall Street can be part of the solution.
Administration officials said the plan, to be announced Tuesday, was likely to depend in part on the willingness of private investors other than banks — like hedge funds, private equity funds and perhaps even insurance companies — to buy the contaminating assets that wiped out the capital of many banks.
The officials say they are counting on the profit motive to create a market for those assets. The government would guarantee a floor value, officials say, as a way to overcome investors’ reluctance to buy them.
Details of the new plan, which were still being worked out during the weekend, are sketchy. And they are likely to remain so even after Treasury Secretary Timothy F. Geithner announces the plan on Tuesday. But the aim is to reduce the need for immediate federal financing and relieve fears that taxpayers will pay excessive prices if the government takes over risky securities. The banks created those securities when credit and home prices were booming a few years ago.
Besides devising a way to bring private investors into the bank bailout, the Treasury plan is expected to inject more capital into some banks and to give many homeowners relief from immediate foreclosures.
It also is expected to increase financing for a Bush administration program intended to encourage investors to finance such things as student loans and credit card debt.
The Treasury Department had intended to unveil the plan on Monday. But on Sunday Mr. Obama’s economic advisers said they would wait another day, to keep the focus on winning Senate approval of an economic stimulus program. Mr. Obama plans to promote the stimulus package in a televised news conference Monday night.
The stakes for the Obama administration’s bank bailout proposal are high, economists say. Regardless of the specifics of the differing economic plans pending in Congress, no spending stimulus is likely to have much long-term effect unless the bank bailout works.
“The simple truth is that a self-sustaining expansion in a capitalist economy absolutely requires a functioning banking system,” said Robert Barbera, the chief economist of ITG, an investment advisory firm. There is a general agreement that previous efforts have yet to succeed.
When the Bush administration introduced its original $700 billion bank bailout plan last fall, the government was supposed to be the primary buyer of the damaged assets — the securities tied to subprime mortgages and other dubious loans whose value plunged as the financial crisis intensified. The idea was to pay more than private buyers were willing to spend, but less than the assets might eventually be worth after a recovery.
After it turned out that the banks were in even worse shape than thought, the Bush administration decided it was more important to invest directly in the banks.
It was also unclear how the assets would be valued, raising political questions about whether the purchase prices would be fair both to the banks and to the taxpayers. But as those assets have remained on the banks’ balance sheets, they have continued to decline in value, producing more multibillion dollar losses.
The securities are complex and hard to evaluate, and there is little public information about precisely which assets are owned by each bank. And some prospective purchasers say banks are not making many available for sale, or have refused to accept the prices being offered.
The Obama administration, in proposing its plan, will be seeking to spend the remaining half of the original $700 billion in bailout money.
By trying to bring in private sector buyers to set prices for the distressed assets, and to take some but not all of the risk that the asset value will continue to decline, Obama officials evidently hope to restore confidence in the banking system. They will also try to avoid the politically perilous course of having the government directly buy the assets at prices that could turn out to be far higher, or lower, than their eventual value.
The assets were the product of a market that grew rapidly in the past two decades, in which loans made by banks, and sometimes by others, were packaged into investment securities with varying levels of risk.
Because of the hedging of risks, some were presented as safe, even if the underlying loans were risky. When these securitized assets were being created, federal regulators declined to regulate this rapidly expanding shadow financial system. Alan Greenspan, then the chairman of the Federal Reserve, argued that the complex securities were improving the safety of the banking system by transferring its risks to outside investors.
It turned out that he was wrong, as became clear when the crisis spread last year.
A possible model for the way the new Treasury plan could work arose in a deal last July that had no government involvement. In that case, Merrill Lynch sold $31 billion in securities for 22 cents on the dollar. The buyer, the Lone Star group of private equity funds, put down only one-quarter of the purchase price and had the right to walk away, forfeiting only the down payment, if it later turned out the securities were worth even less than it had agreed to pay.
Thus Lone Star stands to receive the upside profit if the securities prove to be more valuable, but has only a limited downside risk if they do not.
In such a deal under the Obama administration’s plan, it would be the government that stood ready to absorb losses if they were too large, while also providing some of the financing for the purchases.
Any government-assisted deal would probably need much more public disclosure, some economists say, than was made by Merrill and Lone Star, which did not reveal exactly which securities were involved. Presumably, too, the government would want such packages to be shopped widely to get the best price.
“They must disclose fully exactly what the government is buying, or insuring, or providing financing for,” said Simon Johnson, a professor at the Massachusetts Institute of Technology and former chief economist of the International Monetary Fund. “Congress is really hypersensitive to this issue right now. Believing you can get away with the opaque deals we saw in Citigroup or Bank of America would be a misconception.”
In those deals, in which the government either assisted a takeover or tried to shore up an institution’s balance sheet, the government provided insurance against further losses on portfolios of assets, but did not disclose details of the assets.
The securities that Merrill sold last July, known as collateralized debt obligations, are indicative of the type of assets that helped create the current crisis. They are not backed directly by mortgages, but by securities that in turn are backed by mortgages. Thus their eventual value depends, indirectly, on how many loans are repaid. And that in turn, will be affected by how successful the Obama administration is at repairing the financial system and stimulating the economy.
When they were created, probably from 2005 to 2007, the Merrill securities were rated AAA, the safest rating there is. The fact Merrill was eventually willing to sell them for less than a quarter of face value indicates how far off those ratings were.
If investors previously underestimated the risks of such mortgage-backed securities, they now may be overstating their toxicity — at least in the view of some of the banks that hold them.
The banks argue that the few trades of such securities lately have been at unreasonably low prices — ones that would be justified only if foreclosures, and losses on foreclosed mortgages, are far higher than now seem likely.
But the banks have shown little interest in demonstrating their confidence in the securities by buying more of them from one another. Instead, banks have sometimes been unwilling to trust other banks that hold such securities.
That lack of trust, in turn, has spread to the broader international financial system.
If many of those troubled assets can be removed from bank balance sheets, and others seem to have a clear market value, economists hope that banks would feel freer to lend — rather than continuing to hoard capital to protect themselves from further losses. Only then, the experts say, can the banking system get the economy moving again."
Me:"The officials say they are counting on the profit motive to create a market for those assets."
That's correct. That is the profit motive of the owners of these Toxic Assets. After TARP moved away from the buying of TAs, the price on them fell, and investors like John Paulson started buying them. Perhaps you can ask him how he can buy assets that cannot be priced.
If the government gets in, the price and liquidity will magically rise. The government is putting forth any idea, no matter how awful, in order to avoid nationalizing a few banks. Their master's bidding. Is their no amount of money we won't lose in order to avoid being called socialists?
Don the libertarian Democrat
— Don, Tacoma, WA
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