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Joining Forces To Clean Up Banks

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The Associated Press

Published: March 23, 2009

WASHINGTON - The Obama administration's latest attempt to tackle the banking crisis and get loans flowing to families and businesses will create a new government entity, the Public-Private Investment Program, to help purchase as much as $1 trillion in toxic assets on banks' books.

The new effort, to be unveiled today, will be followed Tuesday with release of the administration's broad framework for overhauling the financial system to ensure that the current crisis - the worst in seven decades - is not repeated.

A key part of that regulatory framework will give the government new resolution authority to take over troubled institutions that would pose a threat to the entire financial system if they failed.

Administration officials think this new power will save taxpayers money and avoid the type of controversy that erupted last week when insurance giant American International Group paid employees of its troubled financial products unit $165 million in bonuses even though the company had received more than $170 billion in support from the federal government.

PUBLIC-PRIVATE INVESTMENT PROGRAM
The plan calls for the new entity to combine its resources with the Federal Deposit Insurance Corp., the Federal Reserve and private investors to buy toxic assets. But the government will put far more money into the deals and take on more risk than the investors, which could include hedge funds, private-equity firms, pension funds and foreign investors with U.S. headquarters.

The Public-Private Investment Program that will be created was viewed as performing the same functions - selling bonds to finance purchases of bad assets - as a similar organization did for the Resolution Trust Corp., which was created to dispose of bad real estate assets during the savings and loan crisis of the 1980s.

Ultimately, the Public-Private Investment Program could buy $500 billion to $750 billion worth of loans.

HOW THE PROGRAM WOULD WORK

TALF EXPANSION: An existing Fed program, known as the Term Asset-Backed Securities Loan Facility, or TALF, that is aimed at reviving nontraditional lending markets will be expanded to deal with toxic securities. These markets, which some call the "shadow banking system," provide nearly half of all U.S. consumer loans.

The program would be expanded to use Public Investment Corp. money to buy some residential and commercial mortgage-backed securities that have high credit ratings. Although details have not been worked out, the plan would require the Fed to offer loans to private investors for a much longer period than the central bank does under TALF, possibly as long as seven years, sources said.

SECOND PRONG: The administration will also launch public-private investment funds to buy toxic assets that back mortgages and other troubled loans.

In this case, the Treasury will provide financing that would match, dollar-for-dollar, money from private investors who participate. In addition, the department will provide a loan to increase the newly formed investment funds' purchasing power.

THIRD PRONG: Use of the FDIC, which insures bank deposits, to support purchases of toxic assets, tapping into this agency's expertise in closing down failed banks and disposing of bad assets.

GENERAL GUIDELINES: To deal with toxic securities, these steps will be taken:

•If a lender wants to dispose of about $10 million worth of residential mortgages, it would approach the FDIC, which would run an auction for interested private investors.

•If the winning bid ended up fetching an $8 million price tag, the FDIC would provide most of the financing and guarantee losses for as much as $6 million.

•The Treasury Department would contribute as much as 80 percent of the rest of the cost of the pool of loans.

•Private investors would contribute only the remaining amount, yet would be in charge of managing the portfolio of loans. Government officials said they would maintain strict oversight over who will run the funds and how the funds will be managed.

FUNDING

The toxic assets plan will use the resources of the $700 billion bank bailout fund, the Federal Reserve and the Federal Deposit Insurance Corp.

Christina Romer, head of the Council of Economic Advisers, said the program would utilize around $100 billion from the $700 billion bailout fund, leaving the fund close to being tapped out.

NEW POWERS SOUGHT FOR TREASURY SECRETARY

•Under the new powers being sought by the administration, the treasury secretary could only seize a firm with the agreement of the president and the Federal Reserve.

•In a role equivalent to a conservatorship, the treasury secretary would have the power to limit payments to creditors and to break contracts governing executive compensation, a power that was lacking in the AIG case.

FINANCIAL REGULATION OVERHAUL

Treasury Secretary Timothy Geithner is expected to reveal the administration's plan to overhaul the financial regulation system in testimony he is scheduled to give Tuesday and Thursday before the House Financial Services Committee.

He is expected to ask Congress to pass legislation that would provide the government with the authority to take over non-bank financial firms on the brink of collapse. Government officials said that if they had such powers last fall, they could have seized AIG and wound down its troubled businesses at far less cost to taxpayers.

Also, he is expected to offer more general proposals on limiting excesses seen in executive compensation in recent years, where the rewards prodded extreme risk-taking.

The administration is working to unveil its proposed regulatory changes ahead of a meeting of the Group of 20 economic leaders, which Obama will attend on April 2 in London. European nations have complained that lax financial regulations in the United States set the stage for the current crisis.

PIECE OF THE PUZZLE

The toxic asset initiative is only one piece of the administration's financial rescue package, which includes efforts to stabilize banks, aid consumer credit markets and provide relief for struggling homeowners to head off foreclosures, a Treasury official said.

The government's effort to deal with toxic assets and loans harkens back to the original intent of the Troubled Assets Relief Program, or TARP, that Congress approved in October.

PUBLIC-PRIVATE INVESTMENT PROGRAM
FUNDING

NEW POWERS SOUGHT FOR TREASURY SECRETARY

FINANCIAL REGULATION OVERHAUL

PIECE OF THE PUZZLE

Information from The Washington Post and The New York Times was used in this report.

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