Geithner's Latest Gamble: a Plan to Buy up to $1 Trillion in Toxic Assets

The Treasury Department will foot part of the bill to encourage private investors to buy the assets.

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After days of speculation, the Treasury Department unveiled the details this morning of its plan to buy up to $1 trillion in toxic assets from banks with the help of private investors. The plan is meant to be a kind of happy medium between waiting for banks to fix the problem themselves and taking full ownership of the assets. Even so, there are still risks for the government, which will necessarily share in any profits—or losses—on the investments.

Although the Treasury has taken a number of steps to fix the financial system, Treasury Secretary Timothy Geithner wrote in a Wall Street Journal op-ed this morning, "The financial system as a whole is still working against recovery." In particular, banks are resisting lending cash because they're afraid that the toxic assets that they still have on their books will continue to devalue. That has frozen up the flow of credit necessary for businesses and organizations to operate and for individuals to get loans.

To reverse that trend, the Treasury will foot half of the capital for the investment funds that will purchase those toxic assets. The other half will come from private investors. Through auctions that investors will compete in for the loans, the Treasury hopes that prices will be driven up. And to help attract investors, the Federal Deposit Insurance Corp. will guarantee debt that the funds issue.

The approach of using a private-public partnership, says a Treasury fact sheet on the program released this morning, "is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly." Hoping for banks to take care of the problem themselves can prolong the crisis, as it did in Japan, the release says, but if the government acts alone, "taxpayers will take on all the risk of such purchases."

The theory underlying the decision is that those "legacy assets," which include real estate loans and securities backed by loan portfolios, aren't actually worth as little as they're going for at the moment. Instead, officials are banking on the idea that their value has been depressed mainly because of fear in the market. But taxpayers will be hoping that they're right, because even with the public-private partnership, the plan means that the government will share not only in any profits made on the investments but also in any losses.

The plan's ultimate price tag could be between $500 billion and $1 trillion. The initial investment, shared by Troubled Asset Relief Program funds and by private investors, will be between $75 and $100 billion.