Treasury Secretary Tim Geithner unveiled his long-awaited plan to deal with the toxic assets weighing on banks' balance sheets on Monday, in an effort desinged to fix a financial system which continues to face acute pressures that are working against economic recovery.
The coordinated effort of the Treasury, Federal Reserve and Federal Deposit Insurance Corp. will attempt to address the issue of legacy real-estate related assets that Treasury Secretary Timothy Geithner said is reducing banks' willingness to take risks and to lend money to consumers.
This will help banks clean up their balance sheets and make it easier for them to raise private capital, Mr. Geithner said.
The plan calls for the federal government to work with private investors to try to restart the market for the troubled mortgage loans and securities, which in turn officials hope improves the financial condition of banks that have received billions in capital injections from the government already. The federal government will pair up to $100 billion with private capital to generate $500 billion in purchasing power to buy the assets, and Mr. Geithner told reporters the plan could reach up to $1 trillion in size over time.
We have to complement this program with a range of approaches to help get these securities markets back to a point where they're working again, Mr. Geithner told reporters Monday morning.
The Treasury's new plan to purchase trouble assets, The Public-Private Investment Program (PPIP) can be divided into two separate categories which address both the Legacy Loans and Legacy Securities clogging the balance sheets of financial firms.
The Legacy Loans portion of the PPIP is meant to deal with loans which are now stuck on the bank's balance sheets. The Legacy Securities portion of the PPIP deals with pools of loans which normally are handled in the secondary markets and which are held by banks as well as insurance companies, pension funds, mutual funds, and funds held in individual retirement accounts.
A key aspect of the program is to nvolv private investors in setting prices. The Treasury expects that a broad array of investors are expected to participate in the Legacy Loans Program. The participation of individual investors, pension plans, insurance companies and other long-term investors is particularly encouraged. The Legacy Loans Program will facilitate the creation of individual Public-Private Investment Funds which will purchase asset pools on a discrete basis. The program will boost private demand for distressed assets that are currently held by banks and facilitate market-priced sales of troubled assets.
Here's the Outline of the way the process would work for the Legacy Loans portion of the PPIP:
Sample Investment Under the Legacy Loans Program
Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.
Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.
Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.
Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.
Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis — using asset managers approved and subject to oversight by the FDIC.
Here's the Outline of the way the process would work for the Legacy Securities portion of the PPIP
Sample Investment Under the Legacy Securities Program
Step 1: Treasury will launch the application process for managers interested in the Legacy Securities Program.
Step 2: A fund manager submits a proposal and is pre-qualified to raise private capital to participate in joint investment programs with Treasury.
Step 3: The Government agrees to provide a one-for-one match for every dollar of private capital that the fund manager raises and to provide fund-level leverage for the proposed Public-Private Investment Fund.
Step 4: The fund manager commences the sales process for the investment fund and is able to raise $100 of private capital for the fund. Treasury provides $100 equity co-investment on a side-by-side basis with private capital and will provide a $100 loan to the Public-Private Investment Fund. Treasury will also consider requests from the fund manager for an additional loan of up to $100 to the fund.
Step 5: As a result, the fund manager has $300 (or, in some cases, up to $400) in total capital and commences a purchase program for targeted securities.
Step 6: The fund manager has full discretion in investment decisions, although it will predominately follow a long-term buy-and-hold strategy. The Public-Private Investment Fund, if the fund manager so determines, would also be eligible to take advantage of the expanded TALF program for legacy securities when it is launched.