U.S. to Use Funds to Create Massive Debt Buying Market for Bad Loans

U.S. Treasury Secretary Tim Geithner Tuesday unveiled the outline of a plan to rescue financial institutions and unfreeze credit markets. Geithner, however, while providing some bullet points, still didn’t define many details beyond the basics.

Under the plan, the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve, in partnership with private investors, will establish a Public-Private Investment Fund (PPIF) to provide government capital, financing, and guarantees to help get private investment markets working again. The fund will be targeted at the “legacy” bad loans and assets that are now burdening many financial institutions. The PPIF would look to buy $500 billion in toxic assets in the near term, a figure that could eventually grow to $1 trillion – far beyond the second half of the $700 billion in the Troubled Asset Relief Program (TARP) fund allotted last year.

“By providing the financing the private markets cannot now provide, this will help start a market for the real estate-related assets that are at the center of this crisis,” Geithner said. “Our objective is to use private capital and private asset managers to help provide a market mechanism for valuing the assets.”

Banks with more than $100 billion in assets will be required to undergo a "comprehensive stress test" to determine if they can continue to lend through a severe downturn. The government said it will provide capital support for institutions that need it.

“There has been lot of confusion about the various programs announced by the government and how these programs are intended to help get the economy on the right track again,” said the American Bankers Association after the plan was unveiled. “The Capital Purchase Program, designed for healthy banks, needs to be separated from programs to aid Wall Street, automobile companies and others.  The vast majority of banks never made the type of toxic subprime loans that led to the current financial crisis and more than 90 percent remain well capitalized.”

The Capital Purchase Program enacted last year by Treasury used nearly all of the first $350 billion allotment of TARP funds. Originally designed to take bad loans off of banks’ balance sheets, then-Treasury Secretary Henry Paulson made an abrupt about face and decided to purchase equity positions in many of the nation’s largest banks.

Under the plan announced Tuesday by Geithner, the government will use $1 trillion to support consumer and small business lending through an expansion of the Term Asset-Backed Securities Loan Facility (TALF). Additionally, the government will increase the federally guaranteed portion of Small Business Administration loans, along with an expedited approval process.

But more details were sparse or simply unavailable, shaking the financial markets as the Dow Jones Industrial Average plummeted nearly 400 points in trading Tuesday. According to politicians and economists who spoke on several news and business programs, the markets were disappointed in the lack of detail in Tuesday’s announcement.

Barry Fromm, CEO of Value Recovery Holdings and a founding member of USA Recovery Group LLC -- a coalition of accounts receivable management (ARM) firms, including many that had worked with the Resolution Trust Corporation in the 1980s and 1990s -- said that economists, forecasters and others should not have expected “a silver bullet in one speech.”