Take Two on Geithner's Toxic-Mortgage Plan

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"an understandable backlash"

Estimates are that it will take anywhere from $1 trillion to $2 trillion to cleanse the banks' balance sheets of bad assets. But Treasury has nowhere near that amount of money available and Congress—particularly after the explosion of public outrage over AIG's bonuses—is in no mood to allocate more funds to save the banks. Treasury is hoping to leverage its dwindling resources by getting private money to invest in the assets, alongside Uncle Sam's resources.

"There's no question that some companies have appeared to move irresponsibly with those [government] funds. There is an understandable backlash," warns Melissa Bean (D-Ill.), a member of the House Financial Services Committee and a key player among moderate Democrats. "It makes it more difficult to get money out of Congress, no question about it."

So how would Geithner's plan work? The partnerships he proposes would be run by private sector investment managers. They would take an investment interest, but Treasury would commit government funds for as much as an 80% equity stake in the partnerships. The government would lend the partnerships additional funds to increase their ability to buy assets. Uncle Sam will also put a floor under losses, limiting the risks of buying into the toxic assets.

Will banks and investors perform?

In short, Geithner hopes that by heavily subsidizing the asset purchases—and limiting the downside risk—he will be able to entice private investors into jump-starting the frozen market for bad mortgage loans.

"We'll essentially have the government trying to drive the market by giving a subsidy to private investors to lower the spread" between what the banks are willing to sell for and what the buyers are willing to pay for the toxic assets, says Daniel Clifton, Washington policy analyst for institutional brokers Strategas Research Partners. "But it's too early to tell if investors will jump in, or how far down the banks will go in terms of selling the assets."

Government officials are counting on those players to participate in establishing market prices for the troubled assets. The difficulty of coming up with a price banks would accept—but which wouldn't leave taxpayers paying too much—has bedeviled previous federal efforts to buy up the assets. Under Geithner's new plan, banks looking to sell off bad loans and mortgage backed securities would put them up for auction and several partnerships would make competitive bids.

TALF expands to stir consumer credit

"The key is that private-equity and hedge-fund players will vie for the assets," says Scott Talbott, head of government affairs for the Financial Services Roundtable. "That's how you get a pricing mechanism going."

At the same time, Treasury also plans to announce an expansion of the effort it has been making with the Federal Reserve to unfreeze the stalled consumer credit markets. The program, known as the Term-Asset Backed Securities Loan Facility, or TALF, got started this past week in an effort to reinvigorate the securitization market for credit cards, auto loans, and small business loans. Previously, TALF financing from the Fed had only been available for newly originated loans. Now Treasury will expand the program to make eligible loans that originated as long ago as 2005. It is also expected to begin including mortgage assets, too.

In addition, Geithner will announce a new program under which the FDIC will also create an entity to buy up and hold mortgage loans. It is unclear how those purchases will differ in detail from the asset purchases made by the public-private partnerships, though the key may simply be that the FDIC can provide another source of funding to help stretch the limited money available to the Treasury for the bank rescue. Analysts estimate that of the original $750 billion allocated by Congress, no more than $100 billion remains uncommitted and available.

"It gives them another arrow in their quiver," says Clifton.

Congress Could Change the Rules Later

No matter how well the plan is now detailed on the page, the central question remains: Will private investors participate? Even before the debacle over the American International Group (AIG) bonuses, many expressed fear that if they joined in with the government, the rules might later change. That has happened repeatedly, as the government has revised the rules governing executive pay for banks that have already received Treasury funds. The furor over AIG's bonuses—which in only a week led to competing proposals to tax away most bonuses at virtually all major banks and Wall Street firms—has spread even more fear that the government is an unreliable investment partner.

While Treasury officials have tried to assure investors that there will be no restrictions on bonuses among participating firms, no one believes Treasury has the final say. As with AIG, Congress will step in if the furor continues, whatever Treasury now promises.

One fear, of course, is that if the bank rescue plan succeeds, private investors could be criticized for having made a lot of money investing in bad banking assets, using government funds. Many worry that they could end up being hauled before Congress to explain what might come to be seen as unreasonable gains if the public's ire doesn't diminish.

"The reactions to AIG last week could have a chilling effect on participation in the program," warns the Roundtable's Talbott. "If people are unwilling to participate, the whole rescue effort could tank."

Sasseen is Washington bureau chief for BusinessWeek. Francis is a writer in BusinessWeek's Washington bureau.