March 24 (Bloomberg) -- The U.S. government’s plan to rid banks of toxic assets may attract investors with financing that helps generate returns as high as 25 percent, fund managers and analysts said.

Loans from the Federal Reserve and Federal Deposit Insurance Corp. debt guarantees will bring out the bidders, said Paul DeRosa, a principal of Mount Lucas Management Corp., a $1 billion hedge fund based in Princeton, New Jersey. That can drive up prices and persuade banks to clear balance sheets by auctioning off illiquid debt and troubled securities, he said.

“The best part is that the buyers will have an advantage because of the government financing and the FDIC backstop,” DeRosa said in a telephone interview. “You can bid more. That’s what will make these assets change hands.” Returns may be 20 percent to 25 percent if the economy thrives, he said.

Treasury Secretary Timothy Geithner unveiled a plan yesterday to remove $500 billion of troubled assets from the books of the nation’s banks, seeking to revive the U.S. financial system without resorting to nationalization.

The government would finance purchases of real-estate assets, using $75 billion to $100 billion of the Treasury’s remaining bank-rescue funds. Geithner said that, if successful, the program may be expanded to cover $1 trillion of assets.

“This makes a lot of sense,” said Laurie Goodman, a senior managing director at Austin, Texas-based Amherst Securities Group LP. Banks that haven’t yet written down the value of bad real estate loans or mortgage-backed securities will be able to sell them at higher prices because of the cheap government financing, she said.

Encouraging Investment

The Public-Private Investment Program would encourage the purchase from banks of certain securities backed by mortgages and other assets, as well as whole loans. It resembles a proposal made last year by John Ryding, chief economist at RDQ Economics LLC in New York, and Matt Chasin, chief operating officer of Sorin Capital Management LLC, a Stamford, Connecticut-based hedge fund that manages about $1 billion.

Ryding and Chasin said that the government should provide long-term loans at inexpensive rates. The loans should be for up to 50 percent of the value of the securities being purchased, known as a haircut, with the securities offered as collateral. They also said that the loans should be non-recourse, meaning that if the borrower defaulted the government could seize only the collateral.

Specific financing terms, including the haircut, duration of loans and other details have yet to be determined, the Treasury said in its statement.

‘Necessary’ Steps

“There are a few more steps than some people anticipated and that’s causing some hesitation, but in broad outlines it’s what we thought was necessary,” said Conrad DeQuadros, senior economist and a founding partner of RDQ Economics. “This could be a positive for the asset-backed securities market.”

The government is providing greater incentives for buyers of whole loans. Under the terms of the plan, investors could receive as much as $6 of debt for every $1 of equity invested in whole loans, boosting their returns when the economy recovers. The government has said it wants investors to hold the assets for three years or more. It would invest $1 of taxpayer money for every $1 of private capital.

Praise From Carlyle

“It’s a step forward and as good a plan as we’re going to get,” David Rubenstein, co-founder of private-equity firm Carlyle Group, said today in interview at a conference in Washington sponsored by the Wall Street Journal. “I’m encouraged by the open-mindedness Treasury has shown.”

Rubenstein said funds run by the Washington-based firm will consider investing through the program.

Pacific Investment Management Co., the world’s biggest bond manager, may buy whole loans and manage funds that purchase mortgage-backed securities in the Treasury plan, Bill Gross, co- chief investment officer of the Newport Beach, California-based firm, said in an interview yesterday with Bloomberg Television.

BlackRock Inc., the largest publicly traded U.S. asset manager, will raise money from investors such as pension funds and endowments for the new programs, Chairman Laurence Fink said yesterday in an interview. The New York-based company may consider creating mutual funds so that individual investors can also participate.

One analyst questioned whether it was appropriate for the federal government to make investments with taxpayer money in volatile securities.

Hedge Fund USA

“This makes the U.S. government a hedge-fund manager,” said Tanya Styblo Beder, chairman of risk-management adviser SBCC Group in New York. “Investors in hedge funds do so voluntarily, after performing due diligence on the skills of the manager. But taxpayers aren’t doing this voluntarily.”

Beder said she also worried about a program that had private investors putting up capital with the government because it left no one clearly in charge.

“The logjam in the markets is phenomenal,” she said. “The illiquidity is breathtaking and this is a non-temporary phenomenon. Big measures are necessary, but you have to look at all these issues. Hasty implementation may have huge unintended consequences.”

DeQuadros said anger over bonuses paid at the American International Group Inc. may indirectly dampen enthusiasm for this program. An uproar over the bonuses, paid after AIG received a bailout, prompted lawmakers to approve a tax on the payments. He said investors may be wary as a result.

“You get some leverage and good financing in this program, but do you feel comfortable partnering with the government at this point,” asked DeQuadros. “That’s an open question.”

To contact the reporter on this story: James Sterngold in Los Angeles at jsterngold2@bloomberg.net

Last Updated: March 24, 2009 11:37 EDT