Can Geithner's Toxic-Asset Plan Work?
The stock market enjoyed an explosive rally on Mar. 23 after Treasury Secretary Timothy F. Geithner at long last unveiled a detailed plan to team up with private investors to rid the banks of troubled mortgage assets. No mystery here: Bolstering major banks so they can start lending again is essential if the economy is going to recover. Will it work? It might, but that may require some sizable bank asset sales to come together by early summer, followed by a steady flow of deals through yearend to get the program off the ground.
Geithner thinks he has the right mix of incentives in place to quickly ramp up the program. But it will take a sustained flow of deals to establish attractive prices for all manner of home loans and mortgage-backed securities, which have been devilishly tough for banks to unload since the credit crisis began back in late 2007.
The Treasury's Public-Private Investment Program aims to create investment partnerships that will combine government cash with equity capital from private investors. Uncle Sam will then lend those partnerships money at below-market rates so they have more funds to buy up the banks' bad assets. By providing much of the funding—and limiting private investors' potential losses—Geithner hopes to spur competitive bidding that will establish realistic prices for the toxic assets and get them off the banks' balance sheets. "The goal is to provide liquidity to the market on reasonable terms," says Larry Summers, head of President Obama's National Economic Council.
So far, private equity giant Blackstone Group (BX), bond mavens Pimco, and other investors have expressed interest in participating. Investors expect Treasury to line up a few high-profile deals by late May or June.
William H. Gross, Pimco's co-chief investment officer, argues that if the government lends to the partnership at rates as low as 2%—which the market expects—investors could pay close to 60 cents on the dollar for the devalued assets with returns of around 15%. Sellers would still have to make concessions, but far smaller ones than if forced to sell at today's fire-sale prices. "Geithner's plan closes the gap significantly, but we'll still have to see if anything crosses the market," says Gross.
With Treasury aiming to buy up to $1 trillion in bank assets, Gross wants to see a monthly deal flow of $150 billion in the second half. It will take that kind of volume to get a sustained lift in prices. "If this is working, you'll start to see housing and mortgage securities prices stabilize, and maybe even go up," says Steven D. Persky, managing partner of Dalton Investments.
Money pros say it will be a month or even two before enough is known about the terms of the deal to decide if it's worth participating. Also, the backlash against AIG's (AIG) bonuses makes a partnership with Uncle Sam risky. "Until we see how the pricing mechanism works, the rates the government is offering, and the expected returns, [we won't know] where the deals are," says Robert A. Eisenbeis, the chief monetary economist for Cumberland Advisors.
Another problem: Bankers are already complaining that they could be forced into big writeoffs if the prices for troubled assets remain too low. If the banks refuse to sign on, the Treasury program will tank. That's one reason why Obama plans to meet with the CEOs of JPMorgan Chase (JPM), Citigroup (C), and other banks on Mar. 27.
So it will be critical that the bidding process narrows the gap between what buyers will pay for the assets and what banks will sell them for. The market is in a deep freeze now, in part, because the two sides don't agree on the value of the tainted mortgage assets. Investors, who don't want to overpay, think most mortgage assets are worth only around 20 cents to 30 cents on the dollar.
But many banks argue that plenty of good mortgages have been knocked down to rock-bottom prices and they want 70 cents to 80 cents on the dollar; accepting less would lead to more ruinous write-offs. And if, as expected, U.S. accounting rulemakers meeting on Apr. 2 make it easier for the banks to avoid such write-downs, the banks may be even less willing to sell at a loss.
Administration officials make clear they expect the banks to take the haircut given the economic stakes. Those that do poorly on the so-called stress tests currently under way may have little choice but to cooperate. If they don't, expect another market mood swing, this time to one of despair.
With Theo Francis