You know those supersales at your local department store in which they offer great deals on a couple of things in the hopes of getting enough people in the door so they can move the crap too? That's sort of what the Treasury Department and Tim Geithner are doing with the bank plan that was rolled out on Monday.
The problem facing America's economy has always been how to sell the worst of the toxic assets that are clogging banks' balance sheets. Geithner and his aides at Treasury cleverly realized that the best approach was to offer great prices on some of the more attractive stuff and hope the garbage would move too. (See 25 people to blame for the financial crisis.)
The plan has three parts. Most people have focused on the first part, which is run by the reliable Federal Deposit Insurance Corp. (FDIC) and about which Geithner provided the most detail on Monday. It covers not the complex bundled loans that have received much attention in the media but troubled loans, like mortgages that haven't been paid for three months or more. The plan offers very favorable financing for private investors who want to buy them. In an example provided by the Treasury, an investor would pay as little as $6 for a loan that had an original value of $100.
Those bad loans are a problem for banks. There are some $230 billion in loans that were overdue by 90 days or more as of Dec. 31, 2008, according to the FDIC. It's a good idea to try and get those moving off banks' books. But what of the bundled, securitized assets? According to the FDIC, the total value of securities on banks' books as of Dec. 31 was $1.7 trillion. How much of those securities are toxic and how does the Geithner plan move them to be sold?
The second part of the program, run by the Federal Reserve, attempts to get at that part of the problem by expanding an existing program. But it covers only some of the toxic securities: residential mortgage-backed securities that were initially AAA-rated but are now toxic. It doesn't cover commercial mortgage-backed securities and other asset-backed securities that are no longer AAA-rated. (See the worst business deals of 2008.)
According to TIME calculations, U.S. banks hold $153 billion in residential mortgage bonds that used to have AAA ratings but have since been downgraded. The calculations are based on numbers from the International Monetary Fund, Fitch Ratings and New York University professor Nouriel Roubini. (Treasury and Federal Reserve officials declined to provide their estimates.) To get those selling, the Fed offers some attractive financing, but it hasn't made those details public and the financing is expected to be considerably less favorable than the FDIC rates. Treasury officials insist they have formulas worked out but are waiting to reveal details. (Read "A Brief History Of: Ratings Agencies.")
That leaves the commercial mortgage-backed securities and other asset-backed securities that were once AAA-rated but have since been downgraded. Those toxic assets will be sold, Treasury hopes, by at least five still untested public-private investment funds that will be created through open bidding among investment banks. Those assets, according to TIME's calculations, amount to about $37 billion on banks' books.
The financing for this part of the plan is much less attractive. For every dollar of equity an investor puts up, the government will put up a dollar of its own, plus up to another two dollars in financing, for a total of 3-1 leverage.
All told, the three plans address about $420 billion in toxic loans and assets that the government hopes to get off the balance sheets of banks. Will that be enough to nurse our nation's biggest banks and financial markets back to health? It's not clear. The plan leaves out tens of billions of dollars in bonds that were never AAA-rated and were hard to sell even in good times. The plan triggered a strongly positive stock-market reaction on Monday, when the Dow Jones industrials soared nearly 500 points. On Tuesday the market slipped 1.5%, as doubts about a speedy bank recovery began to take shape.
"This plan is an important piece of the recovery, but it is by no means the solution," says Joseph Mason, a professor of finance at Louisiana State University and a senior fellow at the Wharton School.