The United States offered on Monday financing for private investors to help cleanse banks of up to $1 trillion in toxic assets that are blocking lending and worsening a deep U.S. recession.
Markets rallied on the news, in contrast to a disappointed reaction last month to the bare outline of Treasury Secretary Timothy Geithner's proposed public-private partnerships.
Questions remained about how the toxic assets would be priced and the stakes are high for Geithner as he seeks to convince investors he has a viable plan to get credit flowing again.
If the U.S. authorities actually succeed in buying up to $1 trillion of 'toxic assets', it would be considered a significant step, said Mamoru Yamazaki, chief economist with RBS Securities in Tokyo.
However, the markets will be disappointed if the programs do not move forward due to problems regarding how the asset value is measured.
Initially, Treasury will pitch in with $75 billion to $100 billion to launch the partnerships, taking the money from the $700 billion financial rescue fund Congress approved in October, a Barack Obama administration official said.
The government money would be put alongside private capital and then leveraged up to $500 billion, or possibly double that amount, with the help of the Federal Deposit Insurance Corp, a U.S. bank regulator, and the Federal Reserve.
Geithner, writing in Monday's Wall Street Journal, said it was necessary to do something to clean up the banking sector and restore lending.
Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience, he said, referring to a decade of economic stagnation in Japan in the 1990s.
Under the program Geithner has crafted, the government will provide the lion's share of the funding to buy up soured assets to encourage private investors to participate.
Geithner is due to brief on the plan at 8.45 a.m. on Monday.
Many investors are concerned at the anger that has been leveled at Wall Street by lawmakers who are seeking to claw back bonuses from companies rescued with public funds.
Investors will be very wary of committing capital at the same time as Congress is vilifying Wall Street on bonuses, Sean Callow, currency strategist at Westpac in Sydney.
If markets have bought the rumor then the risk is they sell the fact of the Geithner plan, he said.
VOTE OF CONFIDENCE
Reaction in global markets was more upbeat.
Asian stocks rose to a two-month high on Monday and European shares jumped in early trade. Currencies rallied against the dollar with the Aussie dollar and sterling, whipped by market turmoil at the height of the crisis, climbing almost 2 percent and 1 percent respectively.
BlackRock, one of the world's largest asset managers, said it was keen to be involved in the plan.
It is definitely our intention to get involved as one of the investment managers in this program, Curtis Arledge, managing director and co-head of U.S. fixed income at the company told Reuters.
One part of the plan would see Treasury provide from 50 percent to 80 percent of the equity capital needed to set up a fund, and the FDIC would lend the partnership up to six times the amount of its combined capital.
Another part aimed at taking mortgage-related securities off bank books would let up to five investment managers put up money, with the government matching it dollar-for-dollar and then providing debt equal to half the combined fund.
The real challenge would be in pricing these toxic assets, said Linus Yip, strategist, First Shanghai Securities, Hong Kong. If the government and banks can reach an agreement on that, then there is a pretty good chance the credit market will return to normal.
OLD MORTGAGE DEBT
By having the managers compete, an Obama administration official said a market could be created for securities that do not currently trade.
To help clear old mortgage debt off bank books, the Federal Reserve would broaden the financing it provides under its new Term Asset-Backed Securities Loan Facility, or TALF.
The TALF, now a $200 billion program, will be bumped up to $1 trillion and will begin accepting older residential mortgage-backed securities that were once rated Triple-A, as well as commercial mortgage-backed securities and asset-backed securities that are Triple-A, as collateral for loans.
An official said no congressional approval was needed to launch the program and indicated that investors would not face tough new executive-pay restrictions, even though Treasury was mindful of lawmakers' anger over executive bonuses at companies that have received government bailouts.
(Additional reporting by Jennifer Ablan in Washington; Editing by Dayan Candappa.)