Toxic Assets: Take it to the Dump

President Barack Obama and Secretary of the Treasury Timothy Geithner are finally ready to release their solution to the toxic assets held by banks and financial institutions. It is three-pronged plan to rid the financial system of toxic assets, betting that investors will be attracted to the combination of discount prices and government assistance.

The plan, outlined in an editorial on Monday by Mr. Geithner, tries to expand existing programs and create new ones, but relies heavily on participation from private-sector investors. The success of this type of plan is very suspect, especially considering the business enivronment that Mr. Obama has created. The same month that they have attacked AIG and are now considering regulating financial executive pay, now they want these people to help them take up virtually worthless assets for the good of the country? As a result, many investors have expressed concern about doing business with the government in this climate - potentially casting a cloud over the program's prospects.

The plan is basically to create a fund that will hold some of these toxic loans, with approximately $100 billion in government funds. Additionally, an additional holding company is formed to hold legacy assets. To target troubled securities, such as mortgage-backed securities, the government will create several investment funds. Treasury will act as a co-investor, in most cases contributing $1 for every $1 contributed by the private sector and sharing in the first-loss position. To target troubled loans, the government will create a Disposition Finance Program with the FDIC. In that case, the government will be a co-investor, but could also agree in some cases to contribute 80% of the financing, with the government putting up $4 for every $1 in private financing. As part of that program, the FDIC would provide guarantees against losses on a pool of loans that a bank wants to sell. The program could guarantee as much as $500 billion in loan investments, with possible costs running into the trillions.

Here is my problem: I fully support a plan to buy up these toxic assets. I have stated that for months, and even argued against the TARP I back in October for specifically that reason. I felt that until you solve the toxic assets on the financial companies books, they will never have enough liquid assets to fully fund the credit markets. I fully support something analagous to the Resolution Trust Corporation (RTC), which was formed to help deinvest assets that were held by the now defunct Savings and Loans (S&L) Companies that caused a major financial crisis of the late 1980s. The RTC was so successful that it actually made a profit for the federal government in the long run.

However, the Obama Administration has basically forced the financial industry to start to fight against the government. They can no longer trust this administration in being pro-business, and do not feel that the government is a fair partner. In fact, this is probably the most anti-business presidency since the 1960s. Even Obama's big busniess supporters such as Warren Buffett has serious doubts. This was so much of an issue that several members of Obama's economic team went on the airwaves on Sunday to defend the government position. They wanted to clarify that they would draw a clear line between companies that get bailouts, and companies that are investors with the government.

The reviews of the plan have been mixed. My favorite guy in the whole world, Paul Krugman, thinks this plan will surely fail. The problem is that with the recent news about regulating bonuses for all financial institutions, there is a significant credibility gap. "The deal is good, but it's not worth it if I'm buying myself into a retroactive tax or a Congressional hearing," the chief executive of a major investment firm said, insisting on anonymity because he did not want to seem at odds with the Treasury Department in the event that his firm ends up participating.

So now Mr. Obama has to go to these same people, and convince them that the federal government is trust worthy enough to invest billions of dollars with to buy up assets that are worth pennies on the dollar. That may be the toughest sell in Mr. Obama's illustrious career. So in general I support the Obama/Geithner plan, though I think it has come a little too late. I still believe that it should have come first, before the stimulus plan or budget. But, that is history, and that is no reason not to support this necessary step. However, selling the plan to financial executives that have become targets of the media and this administration will be an entirely different matter.

UPDATE: The stock markets around the world seemed to like the idea of the Obama/Geithner plan, as the NYSE had its largest rise since November, rising almost 500 points.