Tim Geithner's Toxic-Asset Plan: 8 Things You Need to Know

The Treasury secretary releases more details of key program designed to revive the financial system.


It's not usually a good idea to handle toxic waste without a hazmat suit. But amid the most terrifying financial crisis since the Great Depression, the Obama administration is relying on folks in jackets and ties--bankers and investors--to rid the financial system of its most radioactive sludge. Treasury Secretary Timothy Geithner on Monday released the much-anticipated details of his plan to mop up as much as $1 trillion of the illiquid assets that have been at the heart of the painful credit freeze that took hold back in the summer of 2007. Under the terms of the plan, Uncle Sam will use capital and attractive financing to encourage private investors to buy up these assets, putting additional risk--as well as upside potential--onto the shoulders of taxpayer. "Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience," Geithner said Monday in a Wall Street Journal op-ed piece.

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Here's what you need to know about the plan:

1. What are toxic assets? In the context of the financial crisis, toxic assets generally refer to loans or mortgage securities tied to the real estate boom. The value of such assets--huge quantities of which are now sitting on the balance sheets of banks everywhere--has been hammered by the housing crash. Since there are so few buyers in the market for these assets, it's been nearly impossible to tell how much they are worth. As a result, they remain stuck on banks' books, eroding capital, constricting credit and undercutting confidence. The disposal of these assets is essential to a turnaround in the financial system and the economy as a whole.

2. So how does Geithner plan to get rid of the toxic assets? Geithner's plan involves the creation of several public-private partnerships that could purchase as much as $1 trillion of toxic asset from banks. Uncle Sam would put up to $100 billion from the Troubled Asset Relief Program (TARP) alongside private capital and then use government financing to jack up its purchasing power. Asset purchases would be made in three specific ways. First, the Federal Deposit Insurance Corp and the Treasury Department would provide financing guarantees and matching equity for investors to purchase illiquid loans. Secondly, the Treasury will choose up to five asset managers with applicable experience to attract private capital, which the government will match and leverage with government financing. The asset managers would then use the funds to purchase eligible mortgage-backed securities. Finally, the government will expand a previously-announced program to include certain mortgage-backed securities.

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3. What are benefits of this approach? The Treasury Department argues that the plan holds several advantages over other approaches. First, it enables taxpayers to share some of the risks associated with these assets with the private sector. At the same time, by using government resources and private capital, the plan offers taxpayers more bang for their buck. Finally, since the assets will be auctioned off to the highest bidder, the plan reduces the risk that the government will pay too much for the toxic assets. "With the private sector establishing pricing, there is more validity to the price," says Mark Vitner, a senior economist at Wachovia. "The market is not going to overpay."

4. Will investors participate? The plan only works if investors participate. And on account of the government's generous subsidies, Vitner expects them to jump in. "This is going to present a good opportunity to pick up some assets at attractive prices," he says. But Congressional efforts to recover $165 million in bonuses from AIG might keep some would-be investors on the sidelines, blunting the program's overall effectiveness. Mark Zandi, chief economist for Moody’s Economy.com, argues that these concerns won't derail the plan's success. "The working logic in Washington is that if you get TARP money, you are going to get oversight," Zandi says. "If you don't get TARP money but you are in partnership with the government, you won't get the same oversight."