Toxic Asset - Geithner Attempt at Bail-out

Geithner Attempt At Bail-out

On March 23, 2009, U.S. Treasury Secretary Timothy Geithner announced a Public-Private Investment Partnership (PPIP) to buy toxic assets from banks. The major stock market indexes in the United States rallied on the day of the announcement, rising by over six percent with the shares of bank stocks leading the way. PPIP has two primary programs. The Legacy Loans Program will attempt to buy residential loans from bank's balance sheets. The Federal Deposit Insurance Corporation (FDIC)] will provide non-recourse loan guarantees for up to 85 percent of the purchase price of legacy loans. Private sector asset managers and the U.S. Treasury will provide the remaining assets. The second program is called the legacy securities program, which will buy mortgage backed securities (RMBS) that were originally rated AAA and commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) which are rated AAA. The funds will come in many instances in equal parts from the U.S. Treasury's Troubled Asset Relief Program (TARP) monies, private investors, and from loans from the Federal Reserve's Term Asset Lending Facility (TALF). The initial size of the Public Private Investment Partnership is projected to be $500 billion. Economist and Nobel Prize winner Paul Krugman has been very critical of this program, arguing that the non-recourse loans lead to a hidden subsidy that will be split by asset managers, bank shareholders, and creditors. Banking analyst Meridith Whitney argues that banks will not sell bad assets at fair market values because they are reluctant to take asset write downs. Removing toxic assets would also reduce the upward volatility of banks' stock prices. Because stock is a call option on a firm's assets, this lost volatility will hurt the stock price of distressed banks. Therefore, such banks will only sell toxic assets at above market prices.

However, that argument ignores the possibility of simultaneously adjusting bank liabilities by legislation or regulation, as requested in the September, 2009, $24 billion plan proposed by FDIC chair Sheila Bair, which would have shielded shareholders but could have led to non-astronomical management bonuses. Bair's plan was never implemented. Because the number of commercial bankruptcy filings continues to increase, there is evidence for negative feedback pressure indicating that toxic assets still need to be addressed.