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US plan to purge toxic assets takes shape

(AFP) / 15 March 2009

WASHINGTON - US officials are putting the finishing touches on a plan using public-private partnerships to buy up the toxic assets clogging the financial system and contributing to a crippling credit crunch.

The plan, the outlines of which were unveiled last month, is a key to helping the ailing banking system recover from massive losses suffered in the US real estate meltdown.

Treasury Secretary Timothy Geithner told lawmakers Thursday that "the mechanism that we're going to use is to provide government financing alongside private capital that will make it easier for banks to get rid of a lot of these assets."

Earlier in the week, Geithner told PBS television that "you're going to see us move very quickly in the next few weeks to lay out how we're going to provide financing for these legacy assets."

Analysts say the US banking system has at least two trillion dollars of so-called toxic assets, mainly linked to troubled US mortgages, and that these must be wiped off banks' books for them to resume lending to support economic activity.

The administration of President Barack Obama has pledged at least 500 billion dollars for the program, a move aimed at attracting private investment to revive the market for troubled mortgage-related assets.

Sheila Bair, chair of the Federal Deposit Insurance Corp., in recent interviews suggested the plan could involve hedge funds or other private investors who would put up some capital and get low-cost financing from the Federal Reserve for the remainder.

"We think it will work," she told the public radio program Marketplace.

"We think there is significant interest by many of the banks to have a facility where they can sell these assets. And we think there is significant interest among investors to buy these assets at a reasonable price, so that there's good upside potential."

Bair argued that the government can make "a healthy profit" from the investment.

Still, many analysts are skeptical and say critical details have yet to be worked out.

If the banks are forced to sell at a loss -- one notable transaction last year sold mortgage assets at 22 cents on the dollar -- it could force them to recognize hefty losses and weaken the banking system even further.

Cary Leahey, senior economist at Decision Economics, said the ideal outcome would be using a government backstop so that "the banks would take a smaller loss, hedge funds would be guaranteed against the downside and everyone would win."

Leahey said that if the plan works as intended, the government may have to buy or guarantee only a small portion of the bad assets, perhaps 250 billion dollars, to get the markets functioning.

But he noted that the main reason a plan to purchase the assets was abandoned last year by the Bush administration was that there was no effective way to value the mortgage-related securities in a market that was frozen.

"This brings us back to square one, which is how to price these toxic assets," Leahey said.

"The upside is pretty good if the government is giving low-cost financing or a downside guarantee."

But he said it could be a problem "if hedge funds are willing to buy these assets at 25 cents on the dollar and banks are carrying them at 80 cents on the dollar."

Bob Eisenbeis, economist at Cumberland Advisors, called the approach "a dead end."

"I find it difficult to fully understand how this would get around previous attempts to purchase these assets," he said.

"The only way they will get any buyers to come in is to offer some kind of subsidy, and that increases the potential cost to the taxpayer."

Robert Brusca at FAO Economics said the plan remains murky and may only work if the economy turns around, thereby improving the mortgage market outlook and the prospects for securities tied to these loans.

"The last public-private partnership was Fannie Mae and Freddie Mac and it was a disaster, so why would you do it again?" he said.

"They muddied the waters over what was public and what was private."

Brusca noted that the Treasury has not yet come up with a plan to price the assets, and that it remained unclear whether an auction system would work.

Some analysts say the plan could be aided by a relaxing of the so-called "mark-to-market" accounting rules implemented in recent years that force banks to quickly recognize lower values.

In prior crises such as in the 1980s, banks were able to hold troubled loans at a higher value in anticipation of a recovery.

"When you have a market that's dysfunctional, marking it to market doesn't make any sense," Brusca said.


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