The Obama administration aimed squarely at the crisis clogging the nation’s credit system Monday with a plan to take over up to $1 trillion in sour mortgage securities with the help of private investors. For once, Wall Street cheered.
The announcement, closely stage-managed throughout the day, filled in crucial blanks in the administration’s financial rescue package and formed what President Barack Obama called “one more critical element in our recovery.”
The coordinated effort by the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp. relies on a mix of government and private money — mostly from institutional investors such as hedge funds — to help banks rid their balance sheets of real-estate related securities that are now extremely difficult to value.
The goal, said Obama, is to get banks lending again, so “families can get basic consumer loans, auto loans, student loans, (and so) that small businesses are able to finance themselves, and we can start getting this economy moving again.”
It was a huge gambit and one that came like a tonic to Wall Street, which had panned an earlier outline of the program that lacked detail.
Stocks soared, the Dow Jones industrial average shooting up nearly 500 points, thanks to the bank-assets plan and a report showing an unexpected jump in home sales.
The introduction of the plan was closely choreographed so that the president — rather than Geithner — would be the first administration official to appear on camera at midday to discuss it. Geithner met earlier in the day, before markets opened, with a group of reporters at the Treasury Department to go over specifics. But cameras and broadcast-quality audio recorders were barred.
It was the reverse of what happened Feb. 10. Then, after Obama had helped raise expectations toward Geithner and the plan, the treasury secretary went before cameras and bombed. The Dow plunged about 300 points amid investor confusion about details.
The fleshed-out plan is designed to help fix a value on damaged mortgage loans and other toxic securities.
If the value of the securities goes up, the private investors and taxpayers would share in the gains. If the values go down, the government and private investors would incur losses.
“This will help banks clean up their balance sheets and make it easier for them to raise capital,” Geithner said.
The plan will take $75 billion to $100 billion from the government’s existing $700 billion Troubled Asset Relief Program. The government will pair this with private investments and loans from the FDIC and the Fed to generate $500 billion in purchasing power.
Geithner said purchases eventually could grow to $1 trillion — roughly half of the estimated $2 trillion of toxic assets on bank books now.
On the hot seat, Geithner has a lot personally tied to the success of the new program. His performance in the Cabinet, including his slowness in learning about multimillion dollar executive bonuses paid by insurance giant AIG after taking bailout money, has been severely criticized by some in Congress.
Geithner testifies on Tuesday before the House Financial Services Committee.
Under a typical transaction, for every $100 in soured mortgages being purchased from banks, the private sector would put up $7 and that would be matched by $7 from the government. The remaining $86 would be covered by a government loan.
The plan was introduced ahead of a summit next week in London of 20 major and developing economies struggling with the global recession.
Obama is trying to get other wealthy countries to do more to stimulate their economies with government spending, as the United States has done. However, other countries, particularly ones in Europe, are resisting U.S. calls for more stimulus and would prefer to see more internationally coordinated bank regulation.
The administration was expected to outline its plan for financial regulation overhaul later this week.
Federal Deposit Insurance Corp. Chairman Sheila Bair said she expects her agency will finance as much as $500 billion in purchases of residential and commercial real estate loans.
Bair said the program should help banks clean up their balance sheets and raise fresh capital, though she added that “there may be some banks beyond help.” The agency has said before it expects more bank failures, she said.
A joint statement by the Federal Reserve and Treasury Department said the Fed should play a “central role” in preventing future financial crises. That implied a wish that Congress expand the Fed’s authority in regulating all financial institutions, not just banks.
Geithner said taxpayers still could lose money on the deal to soak up bad assets but there was no fixing the system without risk.
Other options, such as having the government purchase the securities outright or letting them languish on bank balance sheets, would pose even greater vulnerabilities, he said, and it was important to find the right blend of risk versus reward.
“I am very confident this scheme dominates all the alternatives for trying to find that balance,” he said.
The sentiment was echoed by congressional Democrats, who said risk seemed inevitable with any plan big enough to work.
But House Republican Whip Eric Cantor of Virginia called Obama’s plan a “shell game” that hid the true cost.
He said he hoped the administration would consider instead an earlier Republican proposal to set up a government-sponsored insurance program for mortgage-related securities.
The administration plan “seems to offer little incentive for private investors to participate unless the subsidy is made so rich that it comes at the expense of the taxpayer,” Cantor said in a statement.
The new program marks a return by the government to a strategy of acquiring toxic securities. Henry Paulson, who was treasury secretary in the final days of the Bush administration, abandoned plans to purchase these securities, largely because they were impossible to price.
The plan builds on earlier programs to pump money into banks, help some homeowners repay their mortgages and stimulate college, small business and other forms of lending.
“There’s still great fragility in the financial systems, but we think that we are moving in the right direction,” Obama said after meeting Geithner and Fed Chairman Ben Bernanke.
Obama said the plan will allow taxpayers to “share in the upside as well as the downside.”
Treasury officials had no firm forecast on when the government would begin making the asset purchases although market expectations were that the process could begin within weeks.