Govt offering Big Subsidies for Investors

[Indigo Dutton]

This is sort of a long post, so hopefully you are interested in the
subject. I found this article on the NY Times this evening when I was
checking up on the day's news (since I was too late ending work today
to make it to class within the first half of the meeting time, I'm
sitting here doing this while you are there). I don't think we are the
kind of investors who will get to participate in this, but likely the
positive effects will eventually reach us if they pull it off.

Indigo

March 21, 2009
Toxic Asset Plan Foresees Big Subsidies for Investors
By EDMUND L. ANDREWS, ERIC DASH and GRAHAM BOWLEY

This article is by Edmund L. Andrews, Eric Dash and Graham Bowley.

WASHINGTON — The Treasury Department is expected to unveil early next
week its long-delayed plan to buy as much as $1 trillion in troubled
mortgages and related assets from financial institutions, according to
people close to the talks.

The plan is likely to offer generous subsidies, in the form of low-
interest loans, to coax investors to form partnerships with the
government to buy toxic assets from banks.

To help protect taxpayers, who would pay for the bulk of the
purchases, the plan calls for auctioning assets to the highest
bidders.

The uproar over the American International Group’s bonuses has not
stopped the Obama administration from plowing ahead. The plan is not
expected to impose restrictions on the executive pay of private
investors or fund managers who participate.

The three-pronged approach is perhaps the most central component of
President Obama’s plan to rescue the nation’s banking system from the
money-losing assets weighing down bank balance sheets, crippling their
ability to make new loans and deepening the recession.

Industry analysts estimate that the nation’s banks are holding at
least $2 trillion in troubled assets, mostly residential and
commercial mortgages.

The plan to be announced next week involves three separate approaches.
In one, the Federal Deposit Insurance Corporation will set up special-
purpose investment partnerships and lend about 85 percent of the money
that those partnerships will need to buy up troubled assets that banks
want to sell.

In the second, the Treasury will hire four or five investment
management firms, matching the private money that each of the firms
puts up on a dollar-for-dollar basis with government money.

In the third piece, the Treasury plans to expand lending through the
Term Asset-Backed Secure Lending Facility, a joint venture with the
Federal Reserve.

The goal of the plan is to leverage the dwindling resources of the
Treasury Department’s bailout program with money from private
investors to buy up as many of those toxic assets as possible and free
the banks to resume more normal lending.

But the details have been treacherously difficult, politically and
financially, and some of the big decisions are the same as those that
bedeviled the Treasury Department under President George W. Bush last
year.

Timothy F. Geithner, the Treasury secretary, provoked scathing
criticism from investors in February by announcing the broad outlines
of the plan without addressing the tough questions, like how the
government planned to share the risk with investors or arrive at a
fair price for the assets that would neither cheat taxpayers nor harm
the banks.

Although the details of the F.D.I.C. part were still being completed
on Friday, it is expected that the government will provide the
overwhelming bulk of the money — possibly more than 95 percent —
through loans or direct investments of taxpayer money.

The hope is that such a generous taxpayer subsidy will attract private
investors into the market and accelerate the recovery of the country’s
banks.

The key protection for taxpayers, according to people briefed on the
plan, is that the private investors will bid in auctions against each
other for the assets. As a result, administration officials contend,
the government will be buying the troubled loans of the banks at a
deep discount to their original face value.

Because the government can hold those mortgages as long as it wants,
officials are betting the government will be repaid and that taxpayers
may even earn a profit if the market value of the loans climbs in the
years to come.

To entice private investors like hedge funds and private equity firms
to take part, the F.D.I.C. will provide nonrecourse loans — that is,
loans that are secured only by the value of the mortgage assets being
bought — worth up to 85 percent of the value of a portfolio of
troubled assets.

The remaining 15 percent will come from the government and the private
investors. The Treasury would put up as much as 80 percent of that,
while private investors would put up as little as 20 percent of the
money, according to industry officials. Private investors, then, would
be contributing as little as 3 percent of the equity, and the
government as much as 97 percent.

The government would receive interest payments on the money it lent to
a partnership and it would share profits and losses on the equity
portion of the investment with the private investors.

Ever since last fall, industry analysts and policy makers in
Washington have argued that the banking system’s biggest problem was
the huge pile of troubled mortgages and other loans on bank balance
sheets.

Risk-taking institutional investors, like hedge funds and private
equity funds, have refused to pay more than about 30 cents on the
dollar for many bundles of mortgages, even if most of the borrowers
are still current. But banks holding those mortgages, not wanting to
book huge losses on their holdings, have often refused to sell for
less than 60 cents on the dollar.

The result has been a paralyzing impasse. Banks, unwilling to sell
their loans at fire-sale prices, have had less capital available to
make new loans. Mortgage investors, unable to leverage their
investments with borrowed money, have been unwilling to pay more than
fire-sale prices.

To break that impasse, the government’s crucial subsidy is meant to
provide investors with the kind of low-cost financing that has been
utterly unavailable in today’s credit markets.

Administration officials refused to comment on the details of the
plan, and refused to say what kind of interest rates the government
would be charging investors. But government officials have long
maintained that they could charge slightly more than the Treasury’s
own cost of money and still offer rates far less than the private
markets would demand.

To start the program, Treasury will ask banks, like Citigroup or
JPMorgan Chase, to identify pools of residential and commercial real
estate loans that they will be willing to sell through an auction.
Private investors will bid against each other, setting a market price.
No bank will be required to participate.

Analysts worry whether the prices investors offer will be high enough
to induce the banks to sell assets. The hope is that high valuations
at the auctions will increase the price of assets that remain on the
books of banks, bolstering confidence in the sector.

Still, the Treasury Department’s biggest obstacle may be the current
political environment in Washington, where Democratic lawmakers are
furious about the pay packages and bonuses received by executives at
companies being rescued by taxpayers.

Many investment executives said they were worried that participating
in any bailout program would expose them to political wrath and
potentially steep new restrictions on their own pay.

Treasury and Fed officials have remained firmly against imposing any
restrictions on pay for companies investing money in the rescue effort
rather than receiving money from it.

The plan comes as financial institutions continue to fail. Federal
regulators Friday seized control of the two largest wholesale credit
unions — U.S. Central Federal Credit Union and Western Corporate
Federal Credit Union — which together had $57 billion in assets. They
provide financing, check-clearing and other tasks for retail credit
unions.