Obama's $1 Trillion Plan to End Bank Crisis

Investment giant climbs aboard public/private venture to buy bad debt.

March 23, 2009, 7:35 AM

March 23, 2009— -- President Obama said today that his economic team is "very confident" that the administration's newest effort to stabilize banks -- a mix of public and private funds that could total $1 trillion -- will help to free up credit.

The president spoke shortly after Treasury Secretary Timonthy Geithner officially announced the long anticipated program.

The plan aims to remove so-called toxic assets -- many of them bad mortgage investments -- from the banks' balance sheets through a private-public partnership. The program will rely heavily on private investors, such as hedge funds and private-equity firms, to buy up $500 billion to $1 trillion of assets with the government providing incentives such as low interest loans and sharing in both the risk and possible profits.

The plan announcement jolted stocks on Wall Street, with the Dow Jones industrial average rallying nearly 500 points, or 6.8 percent, to 7785.86 -- the fifth biggest point gain in history.

Obama described the Public-Private Investment Program as "one more critical element" in a multi-pronged effort to help the economy recover.

He gave an optimistic assessment that the steps the administration has taken are nudging the economy in the right direction.

Obama said there are "glimmers of hope in the housing market," as well as signs that there is easier access to student loans, small business and car loans.

With the announcement of the latest mega-money project to right the economy, Obama said, "I'm very confident that... we're going to be able to make it happen."

With the bad assets off their balance sheets, banks would be expected to start lending again.

Wall Street seemed buoyed by the announcement, with the Dow up more than 400 points in the day's trading. That was in contrast to last month when Geithner first indicated the administration was considering such a plan, but the lack of details sent the market into a nearly 400 point plunge.

Investment giant BlackRock was downright enthusiastic about the new program.

The investment management firm is applying to be one of the government-selected managers and is willing to raise $5 billion or so of private money to partner with taxpayer dollars, Curtis Arledge, co-head of US Fixed Income Portfolio Management Group, at BlackRock told ABC News.

"We think many of these assets are trading at prices well below their intrinsic value," Arledge said.

BlackRock has already been buying such investments for some of its clients but now hopes to purchase more assets. Arledge said the government dollars and risk guarantees will expand the number of people who enter the mortgage-backed securities market.

The $1 trillion program is Obama's latest attempt to pull the economy out of its dive, but it's not the last. On Tuesday, the administration wil lay out its plans to increase its regulation of Wall Street to ensure that the current crisis is not repeated.

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The administration needs to address two problems. First, banks are not lending because their balance sheets are weighed down by these deteriorating toxic assets. Second, the assets are tough to price because of currently depressed pricing levels.

To solve these problems, the treasury's plan is guided by a program with three general principles.

The new program will use between $75 billion-$100 billion of Treasury funds from the Troubled Asset Relief Program and leverage $500 billion with the potential to expand to $1 trillion of private purchasing power with financing from the Federal Reserve System and the Federal Deposit Insurance Corp.

Using the Fed and the FDIC, the government will leverage private capital by co-investing with the private sector. If the private sector has financing provided by the government, buying these assets becomes a more attractive option.

Second, the administration wants the market, not the government, to set the price for these assets.

"The greatest waste of taxpayer dollars would be us paying too much," an official said.

No Silver Bullet

Third, the private sector will invest alongside the taxpayer on an equal basis, so both parties share the downside risk and upside potential.

To accomplish this, the treasury will partner with the FDIC in a program where banks can bring assets they want to sell to the FDIC. The FDIC will provide leverage, then the assets will be sold in the market, where private market participants will bid on them, thereby setting the price. Then the government can co-invest with the private sector to buy pools of toxic assets and clean up the banks' balance sheets.

To address toxic securities, the treasury will partner with the Fed in a program building on an existing lending program. The Fed will provide leverage for private sector participants to buy securities.

Despite the enormous price tag attached to the program, Geithner said, "Our job is to try to fix this problem in our financial system at least cost to the taxpayer."

"This is not something that shields the private sector from risk," a senior administration official said. "If they do well, we will do well. If we do poorly, they will do poorly as well. So it avoids what's been so wrong in the past where you've had, as the president has said, 'Heads I win. Tails the taxpayer loses.'"

"We have seen and I expect to see a lot of interest from the private sector," Geithner said.

Some investors though might shy away, concerned about a populist revolt.

"There is a fear that if you do well off this, they are going to come after you," said Charles Biderman, CEO of TrimTabs Investment Research, which provides data to investors including many hedge funds. "I wouldn't want to participate with this. I don't want busloads of people coming to my house."

But Joel L. Naroff, president of Naroff Economic Advisors and chief economist for TD Bank, said that investors will participate.

"The question is: how much can they wring from the government to insulate themselves from this," Naroff said. "I don't think they are going to be tarred and feathered if they get involved in a partnership with the government and they make money off of it."

Besides, such profits wouldn't be seen for several years.

"If they are making money off it, it means that the market has moved forward, it means things are getting better and people's focus of attention will have changed," Noraoff said.

House Republican whip Eric Cantor called the plan "a shell game that hides the true cost of the program from the taxpayers that will be asked to pay for it."

The administration emphasizes that there is no "silver bullet" to solve this problem.

"This is a large problem that is going to take a long time to solve," a senior administration official said.

"We're attempting to coax a multitrillion-dollar market back to life in an extremely difficult economic and market environment and that's going to take time," the senior official said.

Today's detailed plan comes a month after the Obama administration first announced it would try to take the toxic assets off the banks' books. But the timing might be difficult.

"There is deep skepticism across the country, deep anger and outrage and frustration," Geithner said.

Because of that skepticism, he said, "We have to engender more confidence in the American people that we are going to use taxpayers' money effectively and wisely."

The public has grown weary of multibillion-dollar bailout after bailout, especially when learning about executives still buying private jets and receiving large bonuses. Last week, the nation learned that some executives at insurance giant AIG had gotten a total of $165 million in bonuses after the company gave received more than $170 billion in government bailouts to remain in business.

And today, ABC News revealed that JP Morgan is spending tens of millions on new corporate jets as well as a plush new hangar for its aircraft.

At the same time, government efforts to rein in such bonuses have made some banks and investors wary of doing business with the government.

Obama Says Some Assets "Completely Worthless"

Obama made the case for today's massive program during his appearance Sunday on "60 Minutes" when he argued that it's necessary to team up with Wall Street because there are "systemic risks" in the economy.

"There are certain institutions that are so big that if they fail, they bring a lot of other financial institutions down with them," he told "60 Minutes."

Still, there is the problem of how to value these "toxic assets" and Obama suggested on "60 Minutes" that some of them may be "completely worthless." Nevertheless, the banks holding them expect to sell them.

"The banks are going to be looking for something like 60 cents on the dollar and that the investors would only be willing to pay 30 cents," Douglas Elliott of the Brookings Institute told "Good Morning America."

Christina Romer, head of the Council of Economic Advisers, told "Good Morning America" that about 8 percent of the investment money will come from private sources, but the rest of the money to buy the toxic assets will come from taxpayers.

She emphasized that the $1 trillion program is just part of the effort to lift the economy that has included money for banks, for small businesses, for homeowners and a stimulus program to spend billions on highways, bridges and other infrastructure programs.

Administration officials said the new program was better than the two other alternatives.

Bad option No. 1: let the toxic assets stay on the banks' balance sheets, "the kind of hands-off approach that has led to other countries having financial crises that lasted years and years as opposed to months and months."

Bad option No. 2: have a single public bank buy up all the toxic assets, an approach in which "the taxpayer would take all the risk instead of sharing the risk" and that could involve the public bank overpaying for the assets.

ABCNew's Jonathan Karl and Charles Herman contributed to this report

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