The government by itself can't fix the worst banking crisis since the Great Depression, but the Obama administration is betting that when given the right incentives, investors' appetites for profits will help unclog lending and put the economy back on solid ground.
In laying out the government's plan to partner with the private sector to buy as much as $1 trillion in bad assets, Treasury Secretary Timothy Geithner said it was the best option to deal with a vexing problem that has plagued both the Bush and Obama administrations.
The issue: How to get the toxic loans and securities off bank balance sheets so that banks can raise money and lend to creditworthy customers. Without such lending, the economy is expected to remain mired in a recession that is already the deepest in decades.
The alternatives were to let the assets sit and continue to deteriorate and drag down bank balance sheets or have the government buy the assets, putting all of the risk on the taxpayer, Geithner said.
"What our job is is to try to fix this problem in our financial system at least cost to the taxpayer," he told reporters at a briefing.
What remains to be seen is if enough banks and investors will participate to make the program work.
One of the biggest concerns is that amid public fury and congressional action about bonuses paid to employees receiving government aid, investors will be too worried that the rules will change midgame. Rather than take the risk that they, too, will be subject to government involvement in pay and other decisions, investors may instead choose to sit this one out.
"The administration and Congress need to realize quickly either they keep this up and they won't get anybody (to participate), or back off," IHS Global Insight chief economist Nariman Behravesh said, noting if investors participate, the program could help the government avoid nationalizing failing banks.
Indeed, Bill Gross, founder of Pacific Investment Management, one of the nation's largest bond investment firms, said he would participate in the program, saying participation could lead to "double-digit returns."
Investors liked what they heard on the toxic asset purchase program. All 30 stocks in the Dow Jones industrial average rose, pushing the popular barometer of the stock market up 497 points, or 6.8%, to 7776. That was the Dow's biggest percentage gain since Oct. 28 and its 20th-largest percentage gain in history.
That stood in stark contrast to the reaction on Feb. 10, when Geithner announced a broad outline of the administration's plan to tackle the financial crisis and boost the economy. Investors, disappointed by the lack of details, bid the Dow Jones industrial average down 4.6%.
This time, Geithner gave concrete details of the Public-Private Investment Program, a joint Treasury, Federal Reserve and Federal Deposit Insurance Corp. program that aims to take so-called toxic assets, such as subprime mortgage loans, off bank balance sheets. Treasury will commit up to $100 billion from the $700 billion financial rescue plan passed last year. The government will then work with private investors to buy up to $1 trillion in bad loans and securities that are clogging bank balance sheets and inhibiting lending.
"These markets are stuck," Geithner said. Without government incentives, investors are not willing to take the risk and buy the assets, forcing the government to step in.