Treasury Presses Ahead With Plan For Toxic Assets
New Body to Work With Private Investors

By David Cho
Washington Post Staff Writer
Sunday, March 22, 2009

The Treasury Department will unveil the next step in its financial rescue efforts tomorrow, announcing that it intends to create a government body, called the Public Investment Corp., to finance the purchase of as much as $1 trillion in soured loans and toxic assets from ailing banks, according to sources.

The plan calls for the new entity to combine its resources with the Federal Deposit Insurance Corp., the Federal Reserve and private investors to buy those loans and other assets. But the government will put far more money into the deals and take on more risk than the investors, which could include hedge funds, private-equity firms, pension funds and foreign investors with U.S. headquarters, the sources said. The corporation will be funded with $75 billion to $100 billion from the $700 billion financial rescue package.

Key details of the toxic asset purchasing program are not yet finalized, said officials in contact with the Treasury. Some expressed concern that the markets would expect too much out of Monday's announcement. When Treasury Secretary Timothy F. Geithner first sketched out the administration's rescue plan last month, he was criticized on Wall Street and on Capitol Hill for being too vague and creating uncertainty in the markets.

The Obama administration also risks a backlash from lawmakers and ordinary Americans who expressed outrage over $165 million in bonus payments by American International Group to employees of its most troubled unit -- despite the firm receiving more than $170 billion in federal aid.

White House officials said they are seeking a solution to the AIG bonus controversy in light of a bill that the House passed Thursday that would impose punitive taxes on bonus payments at all financial firms. Industry officials say the House measure would scare off many banks from taking government aid because the majority of their employees receive bonuses. The banks could still survive, but without federal assistance they would not have enough capital to restart lending, which is considered central to reviving the economy.

The administration's goal, one senior official said, is to pursue compensation reform that addresses public outrage while maintaining stability in the financial system.

The toxic asset initiative is only one piece of the administration's financial rescue package, which includes efforts to stabilize banks, aid the consumer credit markets and provide relief for struggling homeowners to head off foreclosures, a Treasury official said.

"Our singular focus is on increasing lending to support economic recovery. Everything we do to stabilize the financial system is done with that goal in mind," added Stephanie Cutter, a Treasury adviser to Geithner. She declined to discuss details of the plan. "Ridding bank balance sheets of problem assets is the next step in that process, but it alone won't solve the credit problem."

The government's effort to deal with toxic assets and loans harkens back to the original intent of the Troubled Assets Relief Program, or TARP, that Congress approved in October.

After the measure was signed into law, Bush administration officials moved away from directly purchasing the assets partly because they thought it would take too long to develop the right program and because they thought they needed to use the bulk of the rescue funds simply to keep banks alive. Those officials were widely criticized by lawmakers and investors for changing course so suddenly and creating uncertainty about the government's intentions.

Last fall, billionaire investor Warren E. Buffet, Goldman Sachs chief executive Lloyd Blankfein and William H. Gross, the managing director of PIMCO, the largest bond fund in the world, approached Treasury officials about an idea to create investment funds, using public and private money, to buy toxic assets from banks, according to former senior Treasury officials. Buffett is a director of The Washington Post Co.

The Obama administration further developed that proposal to address the two main problems banks are facing: troubled debt such as mortgages that institutions are holding until the loans are paid off, plus the complex securities and derivatives that were invented to finance those loans. Both types of assets -- the loans and the complex securities -- have fallen in value. Banks are stuck with them, hindering their ability to lend.

To deal with the troubled loans, the administration would combine resources from the FDIC and the Public Investment Corp. to create several investment funds that could ultimately buy $500 billion to $750 billion worth of loans.

Here's how the program could work: If a lender wants to dispose of about $10 million worth of residential mortgages, it would approach the FDIC, which would run an auction for interested private investors. If the winning bid ended up fetching an $8 million price tag, the FDIC would provide most of the financing and guarantee losses for as much as $6 million. The Treasury would contribute as much as 80 percent of the rest of the cost of the pool of loans. Private investors would contribute only the remaining amount, yet would be in charge of managing the portfolio of loans. Government officials said they would maintain strict oversight on who will run the funds and how the funds will be managed.

To deal with toxic securities, the government has developed two separate initiatives.

One would expand an existing Fed program, known as the Term Asset-Backed Securities Loan Facility, or TALF, that is aimed at reviving non-traditional lending markets. These markets, which some call the "shadow banking system," provide nearly half of all U.S. consumer loans. The program would be expanded to buy some residential and commercial mortgage-backed securities that have high credit ratings using money from the Public Investment Corp. Although details have not been worked out, the plan would require the Fed to offer loans to private investors for a much longer period than the central bank does under TALF, possibly as long as seven years, sources said.

The administration will also launch public-private investment funds to buy toxic assets that back mortgages and other troubled loans. In this case, the Treasury would provide financing that would match, dollar-for-dollar, money from private investors who participate. In addition, the department would provide a loan to increase the newly formed investment funds' purchasing power. The details of these financing terms, however, have not been worked out, the sources said.

Treasury officials said more information about these programs will be revealed in the coming weeks. The Treasury also intends to ask Congress to pass legislation that would provide the government with the authority to take over large nonbank financial firms on the brink of collapse. Government officials said that if they had such powers last fall, they could have seized AIG and wound down its troubled businesses at far less cost to taxpayers.

"We've made significant progress over the last six weeks in putting the core elements in place to increase liquidity and stabilize the system," Cutter said. "We've got more work to do, and it will take some time for the financial system to recover, but we've done more in weeks than it takes other countries years to do."

Staff writers Binyamin Appelbaum and Michael D. Shear contributed to this report.

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