Treasury Unveils Toxic Asset Plan

The toxic assets that have kept banks from lending to one another and to the rest of the world may finally be cleaned up. Earlier today, the US Treasury Department announced a “Public-Private Investment Program” intended to buy up as much as $500 billion in bad assets initially, although Secretary Timothy Geithner says it could reach $1 trillion. The idea is simply a gigantic vulture fund, and the odds are Uncle Sam will eventually turn a profit doing this.

Vulture funds are nothing new. They are speculative entities that invest in debt issued by virtually bankrupt firms or nations. Market experts may prefer the terms distressed debt or special situation funds, but a spade is still a spade. Since the PPIP will be buying distressed derivatives rather than debt, it may be more accurate to call it vulture investing. In any case, the idea is to have the FDIC coordinate auctions of banks' toxic assets thereby establishing some kind of price based on market forces and helping strengthen the bank's balance sheets.

While the Treasury will probably profit, that isn't the reason for the government to do this. The real reason is to re-establish a market in distressed derivatives, especially mortgage-backed securities. Last autumn, the demand for these products evaporated, and when there are no buyers, there is no market. Mr. Geithner's thinking is to get the market going again by giving private equity a sense of safety by partnering with the US government.

The private sector also needs to be involved because that's really where the expertise in derivatives lies. Although a great many made a pig's breakfast of the situation through greed and unchecked risk taking, the fact remains that they do know more about these instruments than the Feds. With proper guidance from Treasury staff who are more interested in getting a functioning market going rather than a quick fee, they are probably in a position to unwind the mess.

A single nagging concern remains, and that is whether the $100 billion that the Treasury will take from the TARP rescue funds will be enough to get the private equity side to put its toe in the water. It feels like a sufficient amount, but Wall Street is still as nervous as all get out. If initial discussions with some big shots over the week-end are anything to go by, the whole thing has about a 75% chance of getting the banks back in the lending business. In times like these, those are pretty good odds.

© Copyright 2009 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.

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