Market frustrated by lack of detail on US toxic-asset purchase plan

On March 23 US Treasury secretary Timothy Geithner announced that $75 billion to $100 billion of capital from the $700 billion Troubled Assets Relief Program (Tarp) will be allocated to the two-part Public-Private Investment Program (PPIP). Along with private capital, it will be used to purchase between $500 billion and $1 trillion of so-called 'legacy loans' - a euphemism for real estate loans held directly on bank balance sheets - and 'legacy securities', the illiquid residential and commercial mortgage-backed securities (MBS) that have suffered mark-to-market losses in recent years as defaults and foreclosures have soared.

The legacy loans programme would allow banks holding illiquid mortgage portfolios to approach the Federal Deposit Insurance Corporation (FDIC) to auction off the assets, with the regulator first determining the amount of funding it would be willing to guarantee on the mortgage portfolio, up to a maximum debt-to-equity ratio of 6:1.

The mortgage pool would then be auctioned off by the FDIC to private-sector buyers, with the winning bid establishing the price the investor and the Treasury would pay for the mortgages - for example, a mortgage portfolio with a par value of $100 might be auctioned off for $84.

The auction-winning investor will subsequently form a public-private investment fund (PPIF) alongside the Treasury, with both parties providing 50% equity. At the 6:1 debt-to-equity ratio, this would mean the Treasury and the private investor would split a $12 equity stake. The PPIF - guaranteed by the FDIC - would then issue debt for the remaining $72 needed to finance the deal, leaving the private party in the fund in full control of the assets, although "subject to strict FDIC oversight".

The legacy securities programme - designed to remove MBSs from bank and institutional investor balance sheets - is similarly complex. Its first element would see the term asset-backed securities loan facility (Talf) extended - the Treasury would make non-recourse loans to fund private purchases of non-agency pre-2009 residential MBSs originally rated AAA and commercial MBS currently rated AAA.

However, many of the details of the Talf component are yet to be ironed out, with haircuts, lending rates, minimum loan sizes and loan duration all yet to be determined.

The second element of the legacy securities initiative - relating to securities PPIFs - is more oblique still. The Treasury intends to allow up to five private investment managers with a "demonstrable track record in the targeted asset classes" to apply to become approved 'fund managers' who will run the joint public-private funds buying up these securitised assets.

These managers will be given a period of time to raise private capital to "target designated asset classes" of MBSs, after which the Treasury will match the amount raised dollar-for-dollar. How the fund managers will attract private capital was not specified in the release, nor was the mechanism by which they will attempt to price the illiquid securitised assets.

The buying power of the PPIFs could be further strengthened should fund managers apply to the Treasury for senior debt for up to 100% of the fund's total equity capital, pending the meeting of certain guidelines, and restrictions on asset level leverage, redemption rights and other factors the Treasury deems relevant.

Certain details of the PPIP will be subject to discussion with market participants although no details were provided of when such a consultation would begin or end.

The response from economists has been cautious. Many have criticised the lack of definite substance in the proposals, and have pointed out that private investors might be wary of partnering with the US Treasury, given its attempts to levy a 90% tax on bonuses paid out by government-supported insurer American International Group.

"Today's announcement is helpful in moving forward the financial stability plan [but] several questions remain unanswered with respect to the two programmes. The first and most obvious question remains the degree of private sector interest given recent political actions directed against previous recipients of Tarp funds. A second is the large number of details not spelled out in today's announcement, in particular, the fact that terms and conditions concerning the legacy securities programme are confusing and incomplete," said Michael Feroli, US economist at JPMorgan Economics in New York.

"It is unclear how Talf will interact with the legacy securities programme and moreover, the lending rates, haircuts and duration of any Talf loan have yet to be determined. Without this information, the spine of the legacy securities programme is no more complete today than it was on February 10 when Geithner first discussed his plan," he added.

Analysts are also concerned about the priorities of the Treasury, and in particular whether the wellbeing of the PPIP might take second place to political motives.

"If the Fed provides loans to the private sector on sufficiently attractive terms to allow the private sector to make gains, there will be a large political outcry. Equally if the terms are not attractive, then the private sector will be unwilling to inject any money. To compensate for such risks probably means that the terms have to be overly generous and thus risks the political backlash," said Andrew Garthwaite, a London-based equity research analyst at Credit Suisse.

But most market observers welcomed the general intent of the plan.

"Broadly speaking, it looks as if the plan provides some pretty large incentives to private investors [and] it would be useful to see private investor interest, especially when Congress is creating some uncertainty. In any case, progress on making the credit crunch less pervasive is critical, and this seems likely to be a step in that direction as it ramps up," noted Maury Harris, an economist on UBS's global economics research team in New York.

See also: Treasury launches Talf, drops compensation caps
US stress tests under way
Bernanke: Public-private partnership required to value toxic assets
Questions remain over $1trn toxic asset purchase plan

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