Financial Rescue Turns to Toxic Assets

By David Cho and Neil Irwin
Washington Post Staff Writers
Wednesday, March 4, 2009

The Obama administration is aiming to solve one of the toughest riddles at the heart of the financial crisis -- how to value the toxic assets weighing down the books of banks -- by setting up several funds to vie for these securities, sources familiar with the plans said yesterday. By competing to buy assets, the funds could set a market price that would finally allow banks to sell them off.

The government is seeking to attract private investors to manage and put their own money into these funds by offering to cap their losses and share in the risk of buying the troubled assets.

These investors would likely include hedge funds, private-equity firms and other wealthy Wall Street financiers, according to market analysts and industry executives. They said the government could draw political fire for teaming up with these unregulated enterprises.

Obama's team is hoping to unveil this effort, which is the signature program in its multipronged rescue of the financial system, in the next few weeks, a source said.

The size of the initiative could range from $500 billion to $1 trillion, according to Treasury officials. While it is unclear how much of that would come from private sources, Treasury Secretary Timothy F. Geithner warned yesterday that the administration may ask Congress for more rescue funds.

"As expensive as it already has been, our effort to stabilize the financial system might cost more," he said in prepared remarks for a House hearing on the federal budget.

Federal officials in the Bush and Obama administrations have struggled for months to find a way to price these distressed assets, which are backed by troubled mortgages and other loans, that is high enough to help banks but low enough to protect the government from massive losses. Establishing several funds, run by private managers, would take that vexing problem out of the government's hands, allowing market forces to determine what these assets are worth.

This effort shares some similarities with a separate government initiative, the Term Asset-Backed Securities Loan Facility, which officials detailed yesterday. The TALF program -- which begins with $200 billion in public funds and could expand to $1 trillion -- is intended to jump-start the lending markets for education, autos, small businesses and credit cards. Ford Motor Credit, for one, is expected to announce today its intentions to use TALF to sell new securities that would allow people to get loans to buy Ford cars.

The program also relies on private-sector enterprises -- such as hedge funds and private-equity firms -- to determine how much to pay for asset-backed securities, which provide financing for consumer loans. The government would give these private investors loans to help buy the securities and offer to cover some losses. But unlike the program to buy toxic assets, the TALF is focused on newly issued and highly-rated assets.

Both of these initiatives look to tap private investment funds, bond traders and some hedge funds, which are key players in what is often called the "shadow banking system" -- the financial markets beyond traditional commercial banks that provided about 70 percent of credit to borrowers before the crisis. Developed by Treasury official Steve Shafran, a Bush administration holdover, and New York Federal Reserve Bank president William C. Dudley, the TALF initiative is the most sweeping step yet to get these markets functioning again.

"When congressional committees berate bank CEOs for not lending, they entirely neglect this securitized shadow banking world," said William H. Gross, chief investment officer of Pacific Management Co., the nation's largest investor in bonds. "The Fed has recognized that, but it's taken them a while to get this program operating."

Government officials said lending could not return to normal without helping the shadow bankers. Officials said that the more rigorous executive compensation restrictions that apply to banks that receive rescue money would not apply to the hedge funds and other middlemen who make the TALF money available to borrowers.

Both the toxic-assets program and the TALF would involve non-recourse financing. This means the companies can lose the money they invest to buy securities but cannot lose more than they invest.

Stephen Schwartzman, chief executive of private-equity giant Blackstone Group, said the TALF has gotten an encouraging response from the credit markets, which have begun to revive in recent weeks in anticipation. Blackstone, he said, has decided to look into buying up the assets offered in the TALF, though the firm has never bought such securities before.

The government's terms give private firms the potential for making tremendous profits, while limiting the losses private investors could face.

"I think if the government is prepared to partner with the private sector as well as put up leverage to facilitate certain kinds of investment it could be quite interesting to a private-sector investors," Schwartzman said. He added it is very difficult today for most private investors to get such favorable opportunities.

The TALF will begin taking applications from investors March 17 and pumping money out March 25, officials said.

Lenders with big consumer credit divisions that could benefit from the TALF moved higher yesterday on the stock market. American Express shares rose by nearly 7 percent, while Capital One Financial advanced 1 percent.

© 2009 The Washington Post Company