Geithner Wants to Free Banks of Toxic Assets

On Sunday night, the U.S. Treasury Department announced a long-expected plan related to banks’ toxic assets. Via a new government office, a ‘bad bank’, the government will buy for $500 billion in trash credits. That amount can later be expanded to $1 trillion. Secretary of the Treasury Timothy Geithner will explain his plan extensively later today.

According to Geithner, it is necessary to free banks of their toxic assets because these assets are blocking the recovery of the American financial system.

“The entire financial system is still working on its recovery,” Geithner said in the Wall Street Journal. “Many banks do not issue any credits because they are still being pulled down by loans following bad decisions.”

Geithner said the Barack Obama administration established a new “public-private investment program” that will acquire funds to create a market for toxic assets and stocks that have been issued by the banks in the past few years. This program will cost $500 billion, with the possibility of expansion to $1 trillion. The government will issue lucrative subsidies and take on much of the risk to motivate investors to buy these toxic assets.

The market is now waiting for the official introduction of the plan. When Geithner introduced the first version of the plan, investors were so disappointed about the lack of details, that financial stocks were dumped on a large scale. Sources say that the new plan contains more details and Geithner is convinced he will find a lot of support for it.

The plan would, according to sources, consist of three main points. It is a return to the original “Paulson plan”. Henry Paulson, Geithner’s predecessor as treasury secretary, originally wanted to spend the $700 billion Troubled Assets Relief Plan (TARP) on buying toxic assets. This was never executed and the money was spent on infusions of capital to troubled banks and the insurer AIG. Critics quickly stated that the TARP was not about problem assets (Troubled Assets), did not bring any comfort (Relief), and didn’t look like a plan either.

The following points can be distilled from articles in the Wall Street Journal and The Washington Post:

– The treasury will establish a governmental agency to finance the purchase of up to $1 trillion in toxic assets. According to The Washington Post, the agency will be called the Public Investment Corporation. The Wall Street Journal, on the other hand, calls it the Disposition Finance Program.

– That new agency, regardless of its name, will have to join forces with the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve and private investors to buy the assets. The private investors are thought to include hedge funds, private equity players and pension funds, although the American government would do the majority of the investments and carry the majority of the risk. The fund would get $75 to $100 billion, which would come from the $700 billion plan for the financial sector. By bringing in private investors, Geithner hopes to regain “market prices” for problem assets. The problem of all initiatives to buy up problem assets is appreciation: high prices hurt taxpayers and damage the already suffering financial sector. The FDIC would guarantee potential losses on a portfolio of toxic assets of up to $500 billion.

– The Term Asset-Backed Securities Loan Facility (or TALF in short), the credit facility of the Federal Reserve, would be expanded. So far, TALF bought all kinds of newly issued repackaged consumption and KMO credits. The Geithner plan would expand TALF to include older effects, to also deal with the trash credits from this side. Most trash credits date back from 2005 and 2006 already.

Observers remark that Geithner is very dependent on the private sector for the success of his plan. A tricky matter, now that the government and Wall Street are at serious odds with each other, as a result of the issues surrounding ailing insurer AIG. The government wants to tax 91 percent of AIG executives’ bonuses, but Wall Street reacted very critically to that. Some hedge funds are worried about possible public indignation if they earn big profits on the problem assets.