By Neil Irwin and David Cho
Washington Post Staff Writers
Tuesday, March 24, 2009
Financial markets roared ahead yesterday as investors reacted with near-euphoria to the Obama administration's new trillion-dollar plan to stabilize banks by relieving them of their troubled assets and risky loans.
But even as markets exulted, conflicting interests among the program's participants -- banks, investors and taxpayers -- were emerging, leaving in doubt the fate of a program meant to revive bank lending and in turn reinvigorate the overall economy.
Some banks are resisting government pressure to sell assets at prices they believe to be too low. And despite the risk of an outcry from Congress, the Treasury this weekend made the program more attractive to private investors, according to industry and some government officials. Treasury officials said the last-minute changes were not intended to sweeten the deal.
In the short run, the rollout of the plan gave a much-needed boost to the administration and beleaguered Treasury Secretary Timothy F. Geithner, as officials on Wall Street and Washington in general spoke favorably of the plan. The Standard & Poor's 500-stock index rose 7.1 percent in the best day for the stock market in five months.
"The policymakers definitely have the right ideas in their head right now, but whether they can execute it I don't know," said Daniel Alpert, managing director of Westwood Capital, a boutique investment bank.
The new Public-Private Investment Program, which Geithner announced yesterday, includes programs to buy up real-estate-related loans and securities backed by those loans. It will combine $75 billion to $100 billion in financial rescue funds already approved by Congress with investments from private investors, loan guarantees by the Federal Deposit Insurance Corp., and loans from the Federal Reserve to buy up to $1 trillion in real-estate-related assets.
The idea is that banks are unwilling to lend money in part because they fear further losses on past loans now stuck on their books. Government officials said they hope that introducing new buyers will help set a floor for asset prices and stabilize the broader financial system by removing troubled assets from financial firms.
But the initiative leaves the Treasury's financial rescue fund nearly tapped out, and with a hostile environment in Congress, administration officials are worried that they might be unable to get more money.
If the Treasury uses the full $100 billion, it would leave only $12 billion uncommitted from the $700 billion financial rescue package that Congress approved in early October, according to tabulations by the Committee for a Responsible Federal Budget. In turn, that would leave Geithner with few options to provide emergency capital if a major financial firm finds itself on the verge of failure or the "stress tests" now being conducted on large banks reveal an urgent need.
Geithner's credibility with Congress was at a low ebb after the outcry last week over bonuses paid to executives of American International Group. Congressional leaders still say it would be difficult to pass a law giving the Treasury any further funds for financial rescues.
Yet without those funds, the Treasury was forced to stretch the dollars it already has, crafting a plan that is complex and probably more costly to taxpayers over the long term than if Congress provided help.
Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, suggested that a successful rollout of the public-private investment fund could change the tenor on Capitol Hill. "What they're trying to do now is avoid a showdown" between the administration and Congress over more bailout money. "If these things are successful, then I think there would be some more funding down the road."
Geithner and his colleagues at the Treasury Department have been trying to design a program that achieves several objectives: giving private investors plenty of incentive to buy the distressed assets, getting banks to willingly sell these assets and protecting taxpayers from unreasonable risk.
Treasury officials made changes to the plan in recent days in a way that makes it more favorable to private investors, according to government and industry sources. For instance, on Saturday, the draft plan called for the Treasury to put in four times as much equity as private investors, which would give taxpayers a greater windfall if the banking system recovers and the investments become profitable. But Treasury officials surrendered some of those potential gains after listening to the concerns of hedge funds and private-equity funds on Sunday, industry officials said.
The Treasury increased private investors' share of potential profits from 20 percent to 50 percent. A senior official at the department said it was not because the Treasury wanted to make the deal better for the investors but because it wanted to send a consistent message that the government would take the same stake as the private sector across all rescue programs. A smaller Treasury stake also means less risk for taxpayers, the official said.
The response from major investors yesterday was strongly supportive. Bill Gross, co-chief investment officer of Pimco, the nation's largest bond investor, said his firm is eager to participate and that the program is a "win-win-win" policy that "should be welcomed enthusiastically."
Some analysts and senior government officials fear that taxpayers may be giving up too much -- including potential double-digit-percentage returns -- to the investors.
"We are giving the private side a certain package that could well be much more than is necessary to get them, in which case the taxpayers are leaving a lot of money on the table," said Lucian Bebchuk, a Harvard Law School professor who was an early advocate of the government's approach.
"If this is profitable, and I think it will be very profitable, you're giving more profit to private investors," added FDIC Chairman Sheila C. Bair.
Another challenge comes from the banks. Many bankers said they believe their loans and securities are worth far more than current market prices would suggest. They say privately that current prices reflect an overly negative prognosis for the economy. Banks are also worried about the losses they would incur if forced to accept short-term prices for loans that are being held until maturity.
Bair said she cannot guarantee that banks will participate in the program, even though regulators may put pressure on them to do so.
Geithner needed the announcement to go well after facing one of the worst weeks in his young tenure as Treasury secretary, largely because of the furor over the AIG bonuses. Treasury officials had considered delaying the announcement of the program until that controversy blew over, sources familiar with the matter said. But they ultimately decided that the toxic-asset program was too important to delay, the sources said.
Then administration officials tried to lower expectations when talking to the media. The announcement was simplified and pared back, sources said. Originally, for instance, some staffers had urged that the department also provide a public update on the stress test being conducted on banks. This was dropped from the announcement.
Republican members of Congress expressed some skepticism of the bank bailout plan yesterday, though Democratic leaders were more supportive.
"I think it's as good as we can do now," Frank said. "Solutions cannot be qualitatively more elegant than the problems they are aimed at, given where we are and the various constraints."
Staff writer Binyamin Appelbaum contributed to this report.