WASHINGTON - Treasury Secretary Timothy Geithner took the wraps off a key component of the Obama administration's bank-rescue plan yesterday, detailing a public-private partnership to buy the "toxic assets" that bedevil bank balance sheets.
The stock markets reacted enthusiastically: The Dow Jones industrial average shot up nearly 500 points, thanks to the bank-assets plan and a report showing an unexpected jump in home sales. Major stock indexes all surged more than 6 percent; the Dow had its biggest percentage gain since October. The broader S&P 500 index closed above 800. Shares of the biggest banks did especially well.
Geithner's first attempt Feb. 10 to explain the plan sent markets into a nose-dive because of the lack of detail. He spelled out more clearly yesterday how he would use $75 billion to $100 billion in taxpayer money to leverage the purchases of up to $1 trillion in securities and loans held by banks that are eroding confidence in the system.
Under Geithner's plan, taxpayer money and private-sector investment would flow into the Public-Private Investment Program.
The Federal Reserve and the Federal Deposit Insurance Corp. will help provide low-cost financing to subsidize the purchases of distressed bank assets. The Fed will bolster purchases of mortgage-backed securities, the pools of mortgages that are bundled and sold to investors as mortgage bonds. The FDIC will support financing for purchases of mortgage-related loans.
The money to match the private investment will come from the Troubled Asset Relief Program, which was created during October's $700 billion Wall Street bailout.
Geithner said he sought to strike a balance between letting the market alone sort out the problems - risking a deeper, longer recession - and having the government alone buy the assets, risking taxpayers' paying too much.
The compromise was to have private companies - namely hedge funds, private-equity funds, and perhaps pension funds - bid against one another for distressed assets to find their market prices, and to sweeten the deals by having the government join them as an investment partner.
For example, 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.
If the plan works, taxpayers would share in the upside, as markets unfroze and housing-related securities began trading again. If the investments lose money, taxpayers will share the loss.
Some critics think that, under the Geithner plan, the taxpayer is more at risk than private investors. "The value of cheap, multiyear government financing is quite significant, as is the government's promise to put a floor under losses at 10 percent or 20 percent of what the investor puts up," wrote Douglas Elliott, a research fellow at the Brookings Institution, a center-left research group in Washington.
At the core of the nation's banking problems are trillions of dollars worth of mortgage-backed securities. Banks have been forced to write down the value of the assets quarter after quarter because there are no buyers for them. That makes the banks, in turn, hoard their capital to comply with regulatory requirements, rather than lending it. The result is a credit crunch that's contributing to the economic slowdown.
The banks won't sell their declining assets at fire-sale prices, however, in the belief that they have maturity dates and will return to value over time. Investors have been unwilling to touch the assets unless they get steep discounts. Result: no market.
The government's plan seeks to create a market for the assets.
If Geithner's plan succeeds in establishing some preliminary pricing, and the market begins to revive, the administration is likely to seek more money to help it grow. However, Congress must approve such a move, and the mood on Capitol Hill is hostile to more taxpayer bailouts.
Some analysts see promise in Geithner's approach.
"The government can then come in and buy these assets on a large scale at these prices. [Roughly] $1 trillion is not enough; it probably needs to be twice that," said Mark Zandi, the chief economist for Moody's Economy.com, a forecaster in West Chester. "But if the plan works well enough, I think Congress will provide more money to solve the problem once and for all."
Later this week, the administration is expected to outline its plan for financial-regulation overhaul.
A joint statement by the Federal Reserve and Treasury Department yesterday said the Fed should play a "central role" in preventing future financial crises. That implied a wish that Congress expand the Fed's authority in regulating all financial institutions, not just banks.
Highlights of the second federal attempt to spur banks into making loans again. The first was last fall's $700-billion bailout.
Public-private investment: $75 billion to $100 billion in federal money to entice investors to put up a like amount to jointly buy troubled bank assets, mostly mortgage loans.
The purchases: The FDIC would auction the bad loans and provide financing for up to 86 percent for winning bidders. The rest would come from the public-private investments.
Loan expansion: The government will expand an existing loan program to include securities backed by residential and commercial real estate. The program already covers securities backed by credit cards, auto loans, and student loans.
SOURCE: Associated Press