Stalled Initiative to Buy Up Toxic Securities Reignited

After nearly four months of delay, the Treasury on Wednesday launched the Legacy Securities program—a key component of the administration’s Public-Private Investment Program (PPIP) aimed at relieving financial institutions of illiquid assets that continue to hamper the flow of credit markets.

Scaling back the scope of the Legacy Securities program as originally envisioned in March, the Treasury, together with the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve, offered a framework that will provide government investments of up to $30 billion so that private sector fund managers and private investors might purchase legacy commercial mortgage-backed securities (MBS) and non-agency MBS off the balance sheets of banks and other financial institutions.

Selected from a pool of over 100 applicants, below is a list of the nine private fund managers pre-qualified by Treasury to participate in the initial round of the Legacy Securities program:

  • AllianceBernstein, LP and its sub-advisors Greenfield Partners, LLC and Rialto Capital Management, LLC
  • Angelo, Gordon & Co., L.P. and GE Capital Real Estate
  • BlackRock, Inc.
  • Invesco Ltd.
  • Marathon Asset Management, L.P.
  • Oaktree Capital Management, L.P.
  • RLJ Western Asset Management, LP.
  • The TCW Group, Inc.
  • Wellington Management Company, LLP
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At Last

At last Treasury has come forward with its Public Private Investment Program for dealing with toxic assets, only now that there is a plan, the proper term is “troubled legacy assets.” Stocks have rallied since Treasury announced the plan this morning, and legislators on Capitol Hill have halted their rush to claw back the AIG bonus money, some say partly in order to study the new plan. The Treasury Secretary is scheduled to testify before the House Financial Services Committee on Thursday. Will the positive momentum continue up to and following his hearing performance? Secretary Geithner has a lot riding on this week.

The plan, which will use $100 billion of TARP funds, has two parts intended to revive the anemic financial system—the Public Private Investment Fund (PPIF) for Legacy Loans and the PPIF for Legacy Securities. Both are aimed at residential and commercial real estate-related assets. Banks tend to hold the assets as loans and entities such as insurers, pension funds, mutual funds and individual retirement accounts tend to hold the assets as securities backed by loans. The Federal Deposit Insurance Corporation with Treasury will work to create PPIFs that will purchase “loans and other asset pools” from participating banks, and the FDIC will determine eligibility criteria. The FDIC will also be using contractors to help it analyze loan pools and determine the level of debt to be issued by the PPIFs (with leverage not exceeding a 6 to 1 debt-to-equity ratio). The FDIC will then auction off each loan pool to the highest bidder. Treasury will provide 50 percent of equity financing and the private sector auction winner will provide the other 50 percent. The private sector winner can obtain financing by issuing new debt, which the FDIC will guarantee, that is collateralized by the purchase.

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Toxic US Assets & Shuttle Diplomacy

The Obama Administration has stepped up its preparation for the G20 summit next week by moving on two fronts—a plan to purchase toxic assets from banks and a new regulatory regime for financial products and companies. Taken together, these emerging plans appear designed to allow President Obama to come to London saying the U.S. has addressed the three major pillars of a recovery program—stimulus, bank rescue and regulatory reform .

Today's announcement by Treasury Secretary Geithner of the plan for toxic assets follows the broad outline he announced to poor reviews last month. The stock market's swoon after the previous Geithner announcement was blamed on the lack of detail he offered. Today, Geithner described how a program of up to $1 trillion to relieve banks of bad assets will be managed. Based on a public/private partnership concept, the Geithner plan allows for the participation of hedge funds and private equity funds as managers of portfolios of assets. Those managers will have the opportunity to make significant profits if they are successful in selling those assets back into a healthier market in the future. The government will also share in those profits. The reaction of the media and Congress to this plan bears watching. They will focus immediately on the issue of executive compensation for managers participating in the program and on the issue of allowing the very kind of firms that helped create the mess to make a profit on cleaning it up. Careful selection of managers will be crucial.

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Is It Good Not To Be "Bad"?

While a formal announcement is still a day away, it appears the Obama Administration is backing away from the concept of a "bad bank" to take control of the bad assets of US banks. Instead, they will propose that price floors on assets would be set by the federal government as a means of inducing private investors to take control of the assets, manage them, and eventually sell them back into the marketplace.

In explaining the outlines of the proposal on Sunday, Lawrence Summers, the top White House economic adviser, indicated the administration had received a number of proposals from private equity firms, hedge funds, and insurance companies interested in asset management. He said that bringing private equity into the process would help limit the exposure of the taxpayer.

This approach—perhaps best described as a "mixed model"—puts the federal government in the guarantor position and would most likely involve federal oversight of the private firms' activities under the program. Some requirements might flow to the new asset managers as well. For example, a mandate or strong encouragement to restructure mortgage loans could well be a part of the deal for them.

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