How Much Could the Government Lose on TARP?

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The calculated losses don't include the potential hit the government could take on assets that it has guaranteed for some of these banks, such as $300 billion of Citigroup's assets. "By all indications, it sounds like the government doesn't know what they have in the TARP program," says Linssen. "It doesn't know how much [it has] made. My opinion is they don't know how much they're guaranteeing."

If Citigroup's mortgage-backed assets turn out to be worth close to the value of the assets that other TARP recipients are now trying to sell for 30¢ to 50¢ on the dollar, the government would have to take a writedown of at least $150 billion on them once they're sold, says Brigham at Ethisphere. "They are scary numbers," he says.

Understaffed at Treasury

The government is doing its part to provide more transparency regarding the assets on banks' books through stress tests that are supposed to be completed by the end of April. But skeptics argue the stress tests are nothing more than a public relations stunt aimed at boosting market confidence.

If Treasury weren't so understaffed, it would be much more equipped to do the due diligence necessary to gauge the approximate value of the bank assets it is guaranteeing, says Brigham. Bringing staff on board may be much easier if Herb Allison, chief executive of Fannie Mae since September and former CEO of TIAA-CREF, is put in charge of TARP, given his extensive Rolodex and knowledge of the assets, says Brigham.

Then there's the up to $100 billion in TARP funds the government plans to use to subsidize private investors buying toxic assets off banks' balance sheets under the soon-to-be-launched Public-Private Investment Program (PPIP). The goal is that by matching private investors' contributions one-to-one and providing loans at up to six times leverage, the program can generate $500 billion in purchasing power to buy legacy assets—which could expand to $1 trillion over time. And the hope is that these purchases, by providing more price transparency for the assets, will reignite other investors' confidence in these assets.

Stringing Out Investor Cash Flows

But if the debt markets continue to deteriorate and no one can make a profit on these assets, taxpayers would lose their entire investment in the program. There's an additional risk that at the end of the five-year term of the Federal Deposit Insurance Corp.-backed loans made under PPIP, investors might send back the assets they've bought to the government if they haven't appreciated in value by that time, according to Tom Atteberry, a fixed-income portfolio manager at First Pacific Advisors in Los Angeles,

Moreover, the mortgage-modification program proposed by the Obama Administration increases the likelihood of that scenario, Atteberry believes. By reducing the debt-to-income ratio to 31% and raising the loan-to-value refinance standard to 105%, the program will either continue to generate redefault rates between 25% and 50% or it will string out investors' cash flows over a longer period of time, he says.

Even for loans that don't redefault, lowering monthly payments means it will take twice as long for investors to earn the return they've been promised on an asset. And even though borrowers may be able to keep up monthly payments, they probably won't be able to afford maintenance and improvements needed to preserve or increase the property's value and won't be able to refinance at lower mortgage rates, Atteberry says.

Failing Banks Could be Liquidated

The less cash these assets return to investors, the more likely they will be put back to the Treasury. The government is already holding $1.25 trillion worth of mortgages it bought from Fannie Mae and Freddie Mac and it might also get stuck with assets bought under the Term Asset-Backed Securities Loan Facility (TALF) if investors haven't made enough profit to pay back those loans at the end of their three-year terms, says Atteberry. "What is Treasury going to do with all these assets if they are put back to them?" he wonders. "There's potential for much more in losses."

The premise of all the government's actions so far has been that once functioning markets for troubled assets are re-established, asset values will rebound to healthier levels and the downward self-reinforcing cycle will come to an end. If those assumptions are correct, "the Treasury's current approach may prove a reasonable response to the current crisis," the Congressional Oversight Panel said in its Apr. 7 report.

But if Treasury has underestimated the depth of the crisis and the extent to which the low valuation of these assets accurately reflects their worth, then the Treasury may have to turn to "very different actions in order to restore financial stability," including liquidating failing banks, reorganizing them by placing them into conservatorship, or continuing to subsidize the troubled banks with capital infusions, according to the Panel report.

Pushing for Greater Transparency

Atteberry's view is that the market for these troubled assets is already there and securities backed by Alt-A, near-prime, and commercial mortgages trade every day. "The problem is the banks don't like the prices they trade at," he says.

For its part, Ethisphere's intention is to push for greater transparency around the bank assets that the government is either buying, subsidizing, or guaranteeing. "The more you shine light on something, the more accurately it will be measured," says Brigham.

Bogoslaw is a reporter for BusinessWeek's Investing channel.

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