This morning Treasury Secretary Geitner revealed preliminary details to expand the government’s plan to partner with private investors to buy up as much as $2 Trillion in toxic bank assets such as mortgage backed securities and risky home loans.
Under the plan, private investors such as hedge funds and private equity groups would purchase distressed bank assets at auction – presumably at a discount. The FDIC would provide financing – up to 85% for the purchase of these assets. For the remaining 15% equity requirement – up to half – or 7.5% would come from Treasury (ie. “Bailout”) money, with the other 7.5% coming from the private investor. The NY Times diagram below gives a good example.
Personally, in a market where small investors are required to place 20 – 30% down for healthy real estate investments that are performing as intended in a relatively healthy local Austin economy, I find it unsettling that the government is willing to take on 92.5% of the risk and capital requirement for a “toxic” investment. Sure, the idea is that the asset is being purchased at a discount, it doesn’t really matter what you pay for a mortgage backed security if the homeowner on the other end of the line is not paying their mortgage.
Heck, if I can get a bank to loan me 92.5% of the purchase price AND GUARANTEE that they won’t come after me if I default (these are non-recourse), then I will happily sell everything I own that’s not nailed and leverage myself to the hilt to see which assets make some money. After all, if one of the investments turns out to be a dog with fleas, I can just hand it back to the government and let them deal with it, right?
The theory goes that the U.S. taxpayer will profit in the end from: A). Interest payments on the debt by the private investor and B). Future appreciation from the Treasury’s equity slice. I am skeptically optimistic that a public-private partnership is needed to move these assets and jumpstart the economy, but I also believe that the investor needs to be responsible for an EQUITABLE share of risk. Otherwise, we’re inviting an irresponsible buying frenzy that will create a secondary bubble, which is how we got here in the first place.
The plan is being modeled after the Troubled Asset Relief program which dispersed assets from during the S&L Bust in the late 80′s and early 90′s.
Under the plan, the FDIC loans would be non-recourse. If the asset underperforms and the investor walks, the asset goes back to the FDIC, who then would be stuck either carrying the loss or trying to liquidate the bad asset once again.
Fund giant Black Rock says it intends to invest in the plan and is exploring opportunities to create mutual funds for individual investors to buy into. It will be interesting to see how additional details unfold. Hopefully the government will provide significant oversight and restrictions in using its money. I’m all in favor of free market capitalism – let’s just not use taxpayer/government money to subsidize private investors’ risk taking.
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