The New Geithner Plan Public-Private Investment Program

On Monday, March 23, 2009, the Treasury Department announced their new program to help struggling banks with their toxic mortgage assets.  The first change was in semantics, toxic assets will be, henceforth, called legacy assets.  But all kidding aside, this is serious business.  Our economic recovery will depend on the stabilization of the housing market, the restructuring of banks, and in getting credit flowing once again to
credit worthy businesses and consumers.

The plan has three parts.  The first part is run by the Federal Deposit Insurance Corporation (FDIC).  It covers troubled mortgages, but not the CDOs… (bundled mortgage securities)… “legacy assets”.  These mortgages are three or more months delinquent.  The plan offers very favorable financing to private investors to buy these mortgages.  The Treasury gave this example:  An investor could pay as little as $6.00 for a loan that had an original value of $100.

These bad loans are a problem for banks.  It is estimated that there are some $230 billion in loans that are overdue by 90 or more days.  By comparison, the “legacy assets” (CDOs or bundled mortgage securities) amount to $1.7 trillion.

The second part of the program will be run by the Federal Reserve.  The Fed is expanding existing programs, buying up more of those securitized mortgages.  Once again, the plan is to sell those assets to the private sector at favorable financing rates and provide some guarantees.

The third part of the program has to do with commercial mortgage-backed securities and other asset-backed securities that were once rated AAA, but have since been downgraded.  The Treasury hopes to sell these assets to five public-private investment funds that will be created through open bidding amongst investment firms.

To finance the plan, the government will put up to $1.00 per $1.00 from private investors, plus finance up to another $5.00 for a 6-1 leverage.  The plan allocates $75 to $100 billion from TARP Capital. With favorable financing for investors, the Treasury estimates up to $500 billion in purchasing power will be created by this public-private program.  The Treasury has the potential to expand the program up to $1 trillion.

Sample Investment Under the Legacy Loans Program

Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.
Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment
Fund to purchase the pool of mortgages.
Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.
Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.
Step 6: The private investor would then manage the servicing of the asset  pool and the timing of its disposition on an ongoing basis – using asset managers approved and subject to oversight by the FDIC.