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Vast bank rescue plan has perks for investors, risks for taxpayers

WASHINGTON — The Obama administration's new plan to liberate the nation's banks from a toxic stew of bad home loans and mortgage-related securities is bigger and more generous to private investors than expected, but it also puts taxpayers at great risk.

Taken together, the three programs unveiled Monday by Treasury Secretary Timothy Geithner would buy up to $1 trillion in real estate assets that have been weighing down banks, paralyzing credit markets and delaying the economic recovery.

Investors reacted ecstatically, with all of the major stock indices soaring as soon as the markets opened. The Dow Jones Industrial Average ended the day up nearly 500 points, or 6.84 percent, to 7,775.86. The thundering response was the mirror opposite of the bitter disappointment by investors when the plan was first vaguely described on Feb. 10.

"For the first time in seven months, I can say they've done it right," said T. Timothy Ryan Jr., president of the Securities Industry and Financial Markets Association.

Despite lingering worries that Congress would add new pay restrictions or make other changes in the rules, several major investment firms, including BlackRock and Pimco, said they would participate as buyers of bank assets. Banks, which would sell mortgage assets in auctions, were less enthusiastic, though no major bank publicly said it would not participate.

Administration officials outlined a three-part Public-Private Investment Program that offers private investors vast amounts of cheap, taxpayer-supported financing for every dollar they put up of their own money.

In essence, the Treasury and the Federal Reserve will be offering at least a tablespoon of financial sugar for every teaspoon of risk that investors agree to swallow.

"There is no doubt the government is taking a risk," Geithner acknowledged. "The question is how best to do it."

Under one main component of the plan, the Federal Deposit Insurance Corp. would oversee a program in which banks offer up bundles of whole mortgages for sale to investors. The FDIC would set up an auction for each bank portfolio, allowing a bank to sell the mortgages to the investor that offers the highest bid.

But the crucial incentive for investors — traditional fund managers, hedge funds, private equity funds, pension funds and possibly even banks — is that the government would lend as much as 86 percent of the purchase price for each portfolio of mortgages.

On top of that, the Treasury would invest one dollar of taxpayer money for every dollar of private equity capital to cover the remaining 14 percent of the portfolio's purchase price.

The arrangement is similar to some of the distressed-asset sales arranged by the Resolution Trust Corp., the federal agency that was responsible for cleaning up the savings-and-loan debacle of the early 1990s. But the scale of the new program is much bigger.

The initiative leaves the Treasury's rescue fund nearly tapped out, and with a hostile environment in Congress, administration officials are worried they might be unable to get more money for the program, which could end up buying $2 trillion in assets.

What's a toxic asset?

Toxic assets are, mostly, the investments backed by risky subprime mortgages that are held by larger U.S. banks. When defaults on subprime loans — those made to borrowers with tarnished credit histories — began to climb, that gutted the value of the mortgage-backed securities (subprime mortgages bundled together and sold on Wall Street to investors) held by the big banks.

When the banks started writing down the value of the securities, they reported losses in the billions. Their capital eroded; credit dried up. There now are an estimated $2 trillion in bad assets on banks' books.

Vast bank rescue plan has perks for investors, risks for taxpayers 03/24/09 [Last modified: Tuesday, March 24, 2009 7:14am]
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