Monday, March 23, 2009

Obama Seeks Investors in Plan to Buy Illiquid Assets

The Obama administration will announce details of a plan today to expand the $700 billion rescue of the financial system that will rely on enticing private investors to buy the troubled assets clogging banks’ balance sheets.

Treasury Secretary Timothy Geithner, who will unveil the Public Private Investment Program today, has crafted an approach using up to $100 billion of bailout money to spur investment funds to purchase -- and banks to unload -- the illiquid securities and loans that have caused credit to dry up. The Treasury, Federal Reserve and the Federal Deposit Insurance Corp. will all play a role alongside private investors in aiming to buy between $500 billion and $1 trillion of troubled assets.

“By providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets,” Geithner said in an op-ed piece published in today’s Wall Street Journal. “The ability to sell assets to this fund will make it easier for banks to raise private capital.”

The announcement is a major test for Geithner, whose first speech on the financial rescue Feb. 10 offered so few details that it triggered a sell-off in financial stocks. Adding to the pressure on the administration is an unprecedented wave of populist anger over the rescue thus far, following the revelation that employees of American International Group Inc. got $165 million in bonuses after the insurer received taxpayer funds.

Bonus Backlash

The backlash on Capitol Hill means private firms may think twice about taking part in Geithner’s public-private partnership, even though government financing will limit their risk and increase the potential of earning profits, said David Kotok, chairman and chief investment officer of Cumberland Advisors Inc., in Vineland, New Jersey.

“We expect that the participation in the program to be announced this coming week will be tepid at best” because of “fear that any action which puts them into the federal assistance plan will subject them to the chance of retroactive punishment and taxation,” Kotok said.

Hedge Funds

Some executives at private-equity companies and hedge funds, who were briefed on the plan yesterday, are anxious over the uproar involving AIG, the New York Times reported today, citing people briefed on the conversations. Some said they would participate only if the government agreed not to set compensation limits and also worried that disclosure and governance rules could be imposed later, the newspaper said.

President Barack Obama raised caution in an interview broadcast yesterday about attempts to punish Wall Street over bonus payments to a few executives.

“Main Street has to understand, unless we get these banks moving again, then we can’t get this economy to recover,” Obama said in the interview on the CBS News program “60 Minutes.”

“We don’t want to cut off our nose to spite our face,” he said.

Stocks in Europe and Asia today climbed and U.S. index futures advanced on speculation Obama’s plan will revive lending and economic growth. Futures on the Standard & Poor’s 500 Index gained 2.9 percent. The dollar fell as traders bet the steps would spur demand for higher-yielding currencies.

New Treasury Powers

Geithner will also announce plans later this week to ask Congress to give the Treasury and the Fed authority to step in and more easily tackle problems at systemically important financial institutions that are in danger of failing. Such powers would give the government the ability to limit payments to creditors, break contracts on executive compensation commitments and provide guarantees on particular categories of debt for companies that need bailing out.

Officials making the rounds of the Sunday talk shows yesterday stressed that the plan to purge bank balance sheets of troubled assets must be viewed as one piece of the administration’s overall plan to revive the economy and fix financial markets.

“I don’t think Wall Street is expecting the silver bullet,” Christina Romer, the head of the White House Council of Economic Advisers, said on CNN’s “State of the Union” yesterday. “This is one more piece” in a program that also encompasses capital injections into lenders, mortgage adjustments for struggling homeowners and financing to unfreeze the markets for consumer and small business loans.

Subprime Mortgages

American banks have taken more than $800 billion in writedowns and credit losses since the market for subprime mortgages collapsed in 2007. The credit crisis that followed pushed the economy into the deepest recession since 1982. A surge in unemployment and collapse in house prices has added to bad loans and further discouraged banks from lending.

Under today’s plan, Geithner intends to expand the Federal Reserve’s new $1 trillion Term Asset-Backed Securities Loan Facility to provide loans for investors to buy the frozen assets, according to people familiar with the proposal. The TALF currently is only available to fund purchases of top-rated securities. The new program would open it up to so-called legacy assets which are older and not as highly rated.

The revamped Fed program will operate in conjunction with the Treasury’s public-private investment funds. The government expects the funds to compete to buy assets, using auctions to set prices. Private managers will run the funds and use government financing, sharing any profit or loss.

One-Way Bet

The FDIC will oversee investments in whole loans, rather than securities. It will partner with a government program that will provide financing, administration officials said.

In the FDIC partnerships, government loans will allow investors to leverage their funds by 6-to-1, the officials said. The Treasury would provide 50 percent to 80 percent equity in the FDIC partnerships.

Partnerships that rely on the Fed for financing would get less leverage, they said. In these partnerships, the Treasury would probably match investors’ funds dollar for dollar.

“The Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt,” Nobel laureate economist Paul Krugman wrote in the New York Times. “So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets.”

Industry Concerns

Geithner is still working to address industry concerns over whether executive-pay restrictions will apply to the hedge and private equity funds that use the programs, administration officials said. The officials said a distinction needs to be made between companies that received significant bailout help, such as AIG, and private firms that will help the government effort to deal with troubled assets.

“Our government has a responsibility to ensure these funds are deployed to expand the flow of credit to the economy, not to enrich executives or shareholders,” Geithner said in his op-ed article. “These provisions need to be designed and applied in a way that does not deter the participation by the private sector in generally available programs to stabilize the housing markets, jump-start the credit markets, and rid banks of legacy assets.”

Congress last month passed legislation to restrict bonuses at firms that take government aid and is now considering a measure that would heavily tax workers who already received payments.

Bonus Restrictions

On March 19, the House voted 328-93 to impose a 90 percent tax on employee bonuses paid by companies such as AIG that received more than $5 billion in taxpayer assistance. The Senate is considering similar legislation.

Lawmakers said they were pushed over the edge by news that insurer AIG -- which has received more than $170 billion in government assistance -- had agreed to pay some managers millions in bonuses. The employees worked in the unit whose bad bets on derivatives helped drive AIG into collapse and fueled the credit crisis.

Obama has ordered Geithner to “pursue every legal avenue” to recoup the AIG bonuses.

Another concern being reviewed is how to deal with restrictions on hiring foreign workers that Congress imposed on firms that use the TALF.

AIG Bailout

A successful rollout of the plan would ease pressure on the Treasury chief who has been lambasted by lawmakers of both parties over his handling of the AIG bailout. Senator Richard Shelby of Alabama, the senior Republican on the Senate Banking Committee, said yesterday that Geithner is on “shaky ground” with Congress and many other Americans.

“My confidence is waning every day,” said Shelby when asked about Geithner, whose nomination he voted to confirm in January. “If he keeps going down this road, I think that he won’t last long.”

Geithner appears to be safe for now. Obama said he would refuse a resignation offer from Geithner, joking in the “60 Minutes” interview that he would tell the secretary: “Sorry, buddy, you’ve still got the job.”

To contact the reporters on this story: Robert Schmidt in Washington at rschmidt5@bloomberg.net To contact the reporter on this story: Rebecca Christie in Washington at Rchristie4@bloomberg.net



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