Take Two on Geithner's Toxic-Mortgage Plan

The Treasury Secretary lobbies private equity and hedge fund executives as he rolls out a more detailed plan to save the banks

By Jane Sasseen and Theo Francis

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In a much-anticipated move to unfreeze credit markets, the Obama administration on Mar. 23 issued details of its "public-private investment program," to remove hundreds of billions of dollars in toxic mortgage assets from the balance sheets of financial institutions. The plan would deploy up to $100 billion in federal funds and capital from private investors to purchase up to $500 billion in troubled assets, and could be expanded to cover $1 trillion of the assets over time.

Financial markets cheered the plan, with the Dow Jones Industrial Average jumping more than 240 points, or 3.5%, in mid-morning trading. Other indexes also gained. "The actions that we're getting from a policy standpoint are very helpful in removing the sand from the gears," said Alan Gayle, senior investment strategist at RidgeWorth Investments. "That is going to be good for the financials."

Taking no chances on a tepid reception for the launch, Treasury Secretary Timothy Geithner and other Obama Administration officials worked late Sunday to line up support from private equity and hedge fund executives for their plan. The next day, the plan was formally announced with a fusillade of briefings and fact sheets—as well as an effort to rename what the financial industry has been referring to for months as "toxic assets" into the more benign sounding "legacy” assets.

Under the plan, private investors will put up as little as 6% in capital to purchase equity, a number which suprised some observers as quite low. But Geithner, discussing the plan on Monday morning , dismissed those worries by stressing that private investors would be on the hook before taxpayers. "Their entire capital will be at risk, that's the important thing," he said.

If there are gains, however, the government will benefit as well, Geithner said. "If there's a return over time, which we expect there will be, taxpayers will share in that return."

The Geithner plan has broadened somewhat since he first announced in early February that the Treasury intended to join with hedge funds, private equity firms, and other investors in public-private partnerships to buy up the bad assets weighing down banks. Following that speech, investors and others on Wall Street heavily criticized Geithner for providing only vague details as to how the partnerships would work. The stock market immediately tanked, with the Dow Jones industrial average finishing down 4.6% that day.

Wary of a repeat of that performance, Geithner and other officials issued a flurry of detail on Monday. Officials said the plan would rely on three principles: maximizing the impact of each taxpayer dollar, shared risks and profits with private-sector participants, and private sector price discovery for the "legacy" assets.

"This approach is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly," Treasury said in a briefing paper. "Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis, as in the case of the Japanese experience. But if the government acts alone in directly purchasing legacy assets, taxpayers will take on all the risk of such purchases—along with the additional risk that taxpayers will overpay if government employees are setting the price for those assets."

The program will leverage funds using a maximum six to one debt to equity ratio. Officials said by using $75 to $100 billion in capital from the Troubled Asset Relief Program (TARP) and capital from private investors, the plan will generate $500 billion in purchasing power to buy the troubled assets. The program could be expanded to purchase up to $1 trillion in troubled assets.

The size of the program has given some analysts pause. "We think the problem for Treasury is that given the size of problem, they may need additional funds from Congress and as of now, we do not think those funds are available," writes Brian Gardner of investment firm Keefe, Bruyette & Woods.