US Treasury announces debt scheme

Bloomberg

Yesterday’s statement provides details on an initial strategy laid out by Treasury Secretary Timothy Geithner last month, which caused a slump in stocks because it lacked an explanation of how the effort would work. The Treasury, Federal Reserve and Federal Deposit Insurance Corp. will provide capital and financing for private investors to buy illiquid loans and securities held by banks.

"This approach 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," the Treasury statement said. "Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis, as in the case of the Japanese experience."

Half of the Treasury’s funds will go to a "Legacy Loans Program" that will be overseen by the FDIC. The Treasury would provide half of the capital going to purchase a pool of loans from banks, with private fund managers putting up the rest. The FDIC will then guarantee financing for the investors, up to a maximum of six times the capital, or equity, provided.

The FDIC, which has extensive experience disposing of devalued loans from taking over failed banks, will hold auctions for the pools of loans, which will be managed by the private investors with oversight by the FDIC.

A "broad array of investors are expected to participate in the Legacy Loans Program," the Treasury said, encouraging insurance companies, pension funds and even individual investors to join in.

The second half of the Treasury’s contribution will go to the "Legacy Securities Program." The objective of the initiative is to generate prices for securities backed by mortgages that are no longer traded because investors have little confidence about the underlying value of the home loans.

Under this program, the Fed will expand an existing facility that provides financing for investor purchases of asset-backed securities. The Term Asset-Backed Securities Loan Program will be broadened to take on assets such as residential and commercial mortgage-backed securities that were originally rated AAA and sold by private banks.