How will U.S. asset cleanup plan work?

Mon Mar 23, 2009 4:04pm EDT

WASHINGTON, March 23 (Reuters) – U.S. Treasury Secretary Timothy Geithner on Tuesday unveiled his long-awaited plan to cleanse toxic assets from bank balance sheets.

Here are some questions and answers about the plan.

Q: What is the problem the Treasury is trying to solve?

A: The bursting of the U.S. housing bubble caused mortgage failures to skyrocket and triggered massive losses for banks on complex mortgage-related securities. The excessive discounts now embedded on these hard-to-trade assets is weighing down bank balance sheets, choking off lending and worsening an already deep recession.

Q: What is the objective of the Treasury’s plan?

A: The plan aims to bring in private investors to help jump-start the markets for these assets. By providing attractive government financing, the Treasury hopes private investment firms can afford to pay prices for the assets at levels at which banks are willing to sell. With these assets off their books, banks would have capacity to resume lending again, and will be better able to attract private capital. Fears over their potential losses would be greatly reduced.

Q. How much will this cost the government?

A: The Treasury will initially contribute $75 billion to $100 billion from the $700 billion financial bailout fund approved by Congress last fall. It will be able to stretch these funds by combining them with private capital and leveraging them with loans from the Federal Reserve and the Federal Deposit Insurance Corp. Losses for taxpayers could be much larger than the amount the Treasury is using to seed the program, since the FDIC and Fed are extending loans. The Treasury estimates that $500 billion of assets can be bought through the plan, and this could grow to up to $1 trillion. Geithner said he is not ready to decide whether to ask Congress for more bailout money.

Q. How is the plan structured?

A. There are three basic programs. The largest one will enable investors, partnered with the government, to buy whole loans from banks with FDIC financing in an auction process run by the banking regulator. The second would expand a securities loan program run by the Fed to enable firms holding certain mortgage- and asset-backed securities to pledge them as collateral for new loans to invest in these markets. In the third part, the Treasury would hire at least five asset managers to raise capital to buy distressed mortgage- and asset-backed securities. The Treasury would then match the private capital dollar-for-dollar and provide additional debt financing to boost buying power. The funds would compete in the open market to buy legacy securities.

Q. When will the asset purchases get started?

A. The timing is uncertain. Geithner said the Treasury, FDIC and Fed were working “very hard to put it in place as quickly as possible.” A Treasury spokeswoman said the plan would not take as long to implement as the Fed’s securities loan program, which took about four months. The Treasury set an April 10 application deadline for investment managers to run legacy securities funds and will notify winners by May 1.

Q. How would an FDIC loan program investment work?

A. A bank wanting to divest a pool of residential mortgages with a face value of $100 million approaches the FDIC. The FDIC determines how much financing it is willing to extend to potential buyers of the loans, and the FDIC then auctions the loans and chooses the highest private-sector bid. The winner forms an investment fund with both private capital and funds from the Treasury. The FDIC then extends its loan, which can be for up to six times the amount of public-private capital.

For example, if the winning bid is $84 million, at a 6-1 leverage ratio, the FDIC would guarantee $72 million of financing, leaving the fund to raise $12 million in equity capital. At least half of this will come from the Treasury, leaving private investors to find $6 million. But the Treasury could decide to contribute up to 80 percent of the equity in the fund, leaving private investors needing to raise only $2.4 million. In this case, the public sources would be responsible for up to $81.6 billion, or 97 percent of the total.

Q. How would a legacy securities investment deal work?

A. A fund manager selected by the Treasury seeks to raise private capital to jointly invest with the government, which matches the funds dollar-for-dollar. If the fund manager’s sales efforts raise a minimum of $500 million, the government will provide $500 million in matching equity capital. The Treasury will loan the fund another $500 million and may consider additional loan requests. This provides at least $1.5 billion for the fund manager to go shopping for legacy securities. The fund manager has full discretion in investment decisions, although it is expected to pursue a predominantly long-term buy-and-hold strategy. The public-private fund would also be eligible to obtain additional loans from the Federal Reserve’s TALF facility if it acquires qualifying legacy securities.

Q. Will investors and fund managers participating in the Treasury’s program be subject to executive pay restrictions that apply to recipients of government bailouts?

A. No, unless they have already been bailed out. The new plan imposes no restrictions because they are considered “generally available” programs open to investors and designed to get markets working again. Geithner said he will work with Congress to make sure other executive compensation restrictions do not hinder recovery efforts.

(Reporting by David Lawder, Editing by Chizu Nomiyama)

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